Wednesday, September 9, 2009

China Buys First IMF Bonds, Moves away from US Dollar Reserves

Business Intelligence Middle East
Friday, September 4, 2009

DUBAI -- China has agreed to buy the first International Monetary Fund bonds for about US$50 billion, the IMF said.

IMF managing director Dominique Strauss-Kahn and the deputy governor of the People's Bank of China, Yi Gang, signed the agreement Wednesday at IMF headquarters in Washington, the multilateral institution said.

Under the agreement, the Chinese central bank "would purchase up to SDR 32 billion (around US$50 billion) in IMF notes," it said.

SDRs are defined in terms of a basket of major currencies used in international trade and finance. The currencies in the basket are 44% US dollars, 34% euros, 11% Japanese yens and 11% pounds sterling.

SDRs are used as a unit of account by the IMF and other international organizations, that is calculated daily and which members can convert into other currencies.

"The note purchase agreement is the first in the history of the fund," the 186-nation institution said.

The IMF executive board approved the plan to issue notes to governments on 1 July.

China will use yuan, not dollars, to buy the IMF-issued bonds, it was revealed on Friday.The expectation had been that China would use dollars to buy the bonds.

The purchase price of each IMF bond should be paid "by transfer of the SDR equivalent amount of Chinese Renminbi to the account of the Fund", the agreement, which was signed earlier this week, stipulated.

A Chinese central bank official, speaking on condition of anonymity, said it was not clear how the bond purchase would be implemented in practice. One possibility is that the use of yuan is purely a question of accounting convenience.

The IMF might sell the yuan directly back to the Chinese central bank for dollars, hence allowing Beijing to diversify its foreign exchange reserves, said Zhang Bin, an analyst at the Chinese Academy of Social Sciences, a key government think-tank.

The issuance of bonds is an unprecedented step to boost IMF resources as the institution struggles to provide financing to help member nations cope with the global financial and economic crises.

"The agreement offers China a safe investment instrument. It will also boost the fund's capacity to help its membership -- particularly the developing and emerging market countries -- weather the global financial crisis, and facilitate an early recovery of the global economy," the IMF said.

The global economy is beginning to pull out of the worst recession since World War II, according to the institution, but recovery is expected to be sluggish and financial systems remain fragile.

China, whose dynamic economy is expected to lead the global economy out of recession, has been seeking greater representation at the IMF to reflect its rising economic might.

The IMF currently has to raise money by issuing bonds. It has a shortfall of funds due to the financial crisis, yet has to financially support some countries, said Zeng Gang, director of the Department of the Banking Industry of the China Institute of Finance and Banking.

He added that China's holdings of the IMF bond would help give it greater saying and influence in the IMF.

Besides this, holding the bond provides a relatively secure investment, given the risk of depreciation in holding the US dollar.

Since the US dollar holds a smaller proportion than the combination of the other three currencies, holding the IMF bond is safer than US dollar assets.

However, the bond is unlikely to act as the main investment product for China's huge foreign exchange reserves, because the total issue of the bond is only one-tenth of the T-bonds issued by America, and the bond buyer has to bear some exchange risk and interest rate risk, according to market analysts.

Some analysts argue that this bond is more close to debt, as private investors cannot participate and the bond cannot not be traded on a secondary market, which means the investors have to face some liquidity risks.

Brazil, Russia and India -- the other three countries that make up what is known collectively as the BRIC countries -- are seen as potential buyers of IMF bonds and are also in the vanguard of developing countries' drive for greater representation in international bodies.

A deal for Russia to buy up to US$10 billion of IMF should be concluded by September, a senior Russian government official said in early July.

Brazil is also in the market for US$10 billion worth of new IMF bonds.

Any bid by China to expand its formal influence at the IMF is likely to encounter resistance, especially from Europe, which has traditionally provided the fund's managing director.

Chinese think-tank economists said the purchase symbolised the country's "very first step" toward increasing its say in reshaping global financial institutions amid the financial crisis.

The bonds also allow China to diversify its massive holdings of foreign reserves, giving it an alternative to purchasing US State bonds. And it will give the IMF the resources it needs to help other countries battle through the global crisis.

China holds US$2.13 trillion in foreign exchange reserves, the world's largest stockpile, and economists reckon that about two-thirds are invested in dollar-denominated assets.

For further reading:
"China to use yuan, not dollars, for IMF bond buy", Reuters, September 4, 2009
"China to buy $50 billion of first IMF bonds", Associated Press, September 3, 2009

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