MNI INTERVIEW: Emerging Econs Must Diversify USD-China Advisor

Emerging countries should further diversify foreign reserves and prepare for imported inflation as U.S. borrowing adds to a glut of Treasuries, a former senior official of the People's Bank of China told MNI.

The excess of Treasuries supply over foreign demand will prompt a long-term structural change, with the Federal Reserve obliged to sop up issuance and the dollar facing depreciation, Sheng Songcheng, former director of the PBOC's statistics department, said in an interview.

"It is impossible for the U.S. to issue debt without limit, and it will have to stop on the day it cannot afford its interest payments," said Sheng, now professor of Economics and Finance at China Europe International School.

The proportion of the PBOC's forex reserves held in dollars has already dropped while reserves of gold and other investments have risen significantly, Sheng said, noting that emerging economy central banks have been selling dollar holdings and diversifying their reserves since 2014.

According to the latest data from the State Administration of Foreign Exchange, the dollar accounted for 58% of China's forex reserves in 2015 compared to 79% in 1995.

JAPANESE BONDS

Debt issued by other sovereigns, as well as by international financial institutions and big banks with state backing provide alternative safe assets for reserve accumulation, Sheng said, noting that the PBOC increased holdings of Japanese government debt by 360% from April to July last year.

The PBOC reduced its U.S. Treasury holdings by 16%, or USD200 billion, from 2014 to 2020, according to U.S. Treasury Department data.

The PBOC should also further liberalise China's capital account, to permit capital outflows to balance large capital inflows which might otherwise force the central bank to supply extra money to convert for foreign exchange, Sheng suggested.

But, while doing this, the authorities need to keep a careful eye on any potential inflows of hot money, particularly into yuan-denominated bond markets, which are expected to draw increased foreign interest this year, he added.

INTERNATIONALIZATION

Promoting the international role of the yuan should remain a longer-term target, Sheng said, noting that only about 2% of global SWIFT transactions are denominated in yuan, compared to 38% in dollars.

The amended Chiang Mai Initiative Multilateralisation agreement, which took effect on March 31 and will boost the use of non-dollar currencies among ASEAN member states, is an important step towards a more prominent global role for the yuan, Sheng said.

Meanwhile, the additional tolerance for inflation in the Federal Reserve's new policy framework should lead to a weaker dollar and boost commodity prices, Sheng predicted.

"The U.S. will increasingly export inflation worldwide," he said.