A landmark agreement between the Japanese and Chinese governments to invest in each other’s sovereign bonds marks a “significant” step in foreign exchange reserve diversification and the development of the Asian bond market, leading experts said on Thursday.
The move also signals reduced reliance upon the dollar and a move toward increased use of Asian regional currencies in financial transactions, they said.
“We rely too much on the dollar,” Takehiko Nakao, Japan’s vice finance minister for international affairs, said in Manila. The challenge is “how to use regional currencies more widely,” he added, citing the yen, the yuan and the Korean won.
The agreement to make limited purchases of each others’ government bonds announced in Beijing during a meeting between Japanese prime minister Yoshihiko Noda and Chinese premier Wen Jiabao at the end of last year, is seen as a step in this direction.
Japan has also suggested it may invest in South Korean government bonds before long, further diversifying its foreign reserve base.
The Sino-Japanese agreement is a “significant” step, Cyn-Young Park, ADB assistant chief economist told Emerging Markets.
“It is significant because [Japan] are actually trying to diversify their foreign exchange reserves away from US and the euro, especially for Japan where something like 90% of their reserves are in US dollars,” she said
“It [means] that they are really considering non-G3 investment grade bonds as an alternative asset for foreign exchange reserves. Also, the fact that it is the [Japanese] government will send a signal to the private sector that yuan bonds are safe.”
Japan’s initial investment in Chinese bonds is expected to be tiny in relation to the country’s $1 trillion of total foreign exchange reserves, but it is the symbolism more than the size that matters at this point, Park suggested.
“This is all part of a bigger picture of downgrading the dollar as an international currency and reducing dollar hegemony,” said William Thomson, a former ADB vice president and now chairman of Private Capital, Hong Kong and a director of Finavestment in London.
Park said it may take “some time” for the new investment strategies to be adopted but added: “I think it is going to encourage other regional governments to consider yuan-denominated assets as part of their reserves and it will encourage the private sector to invest in yuan denominated bonds.
She said China had to take more steps for the yuan to be actively traded in the bond market. This included encouraging its banks to have more active trading in yuan-denominated bonds and liberalizing their capital account to encourage foreign investors to invest in the yuan.
“The entire [Chinese] banking and financial sector has to do much more give full confidence among foreign investors and traders to have the yuan as part of the global currency [composition],” she said.
“Right now this is more of a political move. The Chinese government granted the right for Japanese government to buy yuan denominated bonds. [Generally] you cannot invest freely in yuan denominated assets. There are a lot of restrictions.”