Action needed to boost confidence in dollar, head off credit downgrade

BEIJING - China on Wednesday urged the United States to take "responsible" policy measures to raise market confidence in the dollar and US government debt as international rating agencies warned of a possible downgrade of the US credit rating amid Washington's debt stalemate.

The State Administration of Foreign Exchange (SAFE), China's foreign exchange regulator, said in a statement that it has noticed the recent warnings from international rating agencies about the US credit rating and the risk of a possible downgrade.

China's dollar-denominated assets will face great risk if the Chinese government doesn't take measures to respond to the trend of a weakening dollar, analysts said. [Photo/China Daily]

"We hope that the US government can take responsible policy measures to boost confidence in the international financial markets and to protect the interests of investors," it said.

Analysts said that SAFE's statement reflected Beijing's concern about the potential risks in its massive holding of US government debt but China is unlikely to substantially cut its US bond holdings because that would weaken the dollar even more.

Beijing's growing stake in the US debt has left its policymakers with limited options for its $3.2 trillion foreign exchange reserves, much of which is invested in US government bonds, which are seen as one of the most liquid investment products in the international financial markets.

"The US debt ... is an important investment product for domestic and international investors," said the statement, published on the regulator's website on Wednesday.

SAFE also said that it was not feasible for China to invest its foreign exchange reserves in global commodities such as gold and oil because that would push up prices and hurt domestic enterprises and consumers.

"The key issue for Beijing is to find alternative and effective ways to invest its foreign exchange reserves and to slow the rapid pace of its accumulation. Before that, Beijing really has very limited options," said Zhuang Jian, senior economist with the Asian Development Bank.

China, the largest foreign holder of US Treasury bonds, increased its holdings by $7.3 billion to $1.16 trillion in May, the second straight month it increased its US debt holdings, according to the US Treasury Department.

As the Aug 2 deadline approaches for US lawmakers to reach a deal to raise the debt ceiling, rating agencies including Fitch Ratings and Moody's Investors Service warned that any missed debt payments by Washington will result in a downgrade of the US sovereign rating.

"Agreement on a credible fiscal consolidation strategy will secure the US AAA status; failure to do so will inevitably weaken the sovereign credit profile and may result in a sovereign rating downgrade," Fitch said in a statement on Monday.

A US government default on its debt is widely seen as unlikely, especially after the Republican-controlled House of Representatives passed a bill on federal spending cuts and a constitutional budget balance amendment in exchange for raising the federal debt ceiling, analysts said.

But Chinese analysts warned about the loose monetary policy of the US Federal Reserve, which could lead to an increasing inflow of speculative capital and put greater pressure on China's already high foreign exchange reserves.

"Any further easing of the monetary policy by the Federal Reserve could result in an increasing inflow of hot money and a possible appreciation of the yuan, which will endanger the country's massive foreign exchange reserves," said Dong Yuping, an economist with the Institute of Finance and Banking at the Chinese Academy of Social Sciences.

"China's dollar-denominated assets will face greater risk if the government doesn't take measures to respond to the trend of a weakening dollar," he said.

SAFE said in the statement that the value of the country's foreign exchange reserves will not be affected because of the yuan's rise against the dollar, unless the reserves were converted into yuan-denominated assets, which would not happen.