By Taimur Ahmad

China will forge ahead with efforts to diversify its $3.3 trillion foreign exchange stockpile into higher yielding assets, including emerging market bonds and currencies, amid expectations of continued poor returns from developed markets, its top forex official has said.

In an exclusive interview with LatinFinance, Yi Gang, director of China’s State Administration of Foreign Exchange (SAFE), said that low US yields following successive rounds of quantitative easing (QE) had thrown up “a lot of challenges”.

Yi, who is also a deputy governor of China’s central bank, said that emerging market assets, including those of Latin America, “are all in our investment sights”, along with developed markets.

“We really have to have a diversified and balanced portfolio,” Yi told LatinFinance in an interview during the annual meeting of the Inter-American Development Bank in Panama.

“We diversify in terms of currency, in terms of asset class, in terms of developed market versus emerging markets, which makes the overall reserve investment diversified and balanced,” he said.

QE ‘challenges’

Yi said that an aggressive policy of quantitative easing by the US “has driven down the interest rate so that [US] bond yields have decreased for years. There are a lot of challenges if you invest in this market.”

US Treasuries, of which China remains the largest foreign buyer, are nevertheless a “major market if you pursue safety and liquidity,” he said.

The deputy governor said he did not think it likely that the US Federal Reserve would wind down its latest round of QE early, despite mounting market expectations to the contrary.

“I think [Fed Governor Ben] Bernanke’s message is very clear [that such an exit would take time],” he said.

EM potential

He added, however, that emerging markets were not “large or deep enough as an asset class” for any substantial Chinese investment. “They have tremendous potential, though right now it’s not very large,” he said.

China’s forex supply was “already large enough”, Yi said. “The marginal benefit of continuing to increase reserves is diminishing.”

But he added that the accumulation of reserves would inevitably slow as the economy rebalances towards domestic demand-led growth.

“We are pursuing a balanced balance-of-payments, and in that case we won’t have a rapid accumulation of reserves,” he said, pointing out that reserves growth had already slowed significantly “in past five or six quarters”.

Currency flexibility

Yi said Chinese authorities were poised to make “significant” moves towards currency flexibility. “You will see significant development in the convertibility of RMB within the next three years,” he said, insisting that China’s currency was already “very close to equilibrium”.

“All the evidence suggests that right now RMB exchange rate, which is around 6.25 to the dollar, is very close to its equilibrium level,” he said.

China was “determined to continue market-oriented reform” of its exchange rate, he added. LF