(Thestandard, Nov 30, 2006) China's best alternative for diversifying its foreign exchange reserves could be to move them into higher-yielding assets denominated in the currencies they are already invested in, a top economist said Wednesday.

Li Yang, a senior researcher with the Chinese Academy of Social Sciences, said that neither shifting some of the more than US$1 trillion (HK$7.8 trillion) in reserves away from dollars nor using them to buy strategic resources - both suggestions from other analysts - were very attractive options.

Li said the cost of any move away from dollars was likely to outweigh the benefit. Spending them on oil and other resources would account for just US$50billion-US$60 billion, he said - just a fraction of the total.

"Previously we mainly invested in Treasuries, but now we could invest in corporate bonds, equities, junk bonds and even derivatives," Li, a former central bank adviser, said. The composition of China's reserves is a state secret, but bankers and academics assume that at least two-thirds is invested in dollar assets, primarily US government debt.

A shift to higher-yielding assets would mark a departure from China's long-held position that it put security and liquidity before returns in managing the reserves.

On monetary policy, Li said he thought the central bank would probably start to use increases in banks' reserve requirement ratios more frequently as a more efficient way of mopping up liquidity than issuing bills.

The central bank has raised the ratio three times this year as part of a drive to cool a liquidity-driven investment boom, and a number of economists have said they expect another 0.5 percentage point rise in the next few months.

To give the central bank more independence in conducting monetary policy, China could also consider creating a separate institution for managing part of its forex reserves, Li said.

Source:Thestandard