Zhou: China will diversify reserves

Updated: 2006-11-14 14:48

China will diversify its $1 trillion foreign exchange reserves, the largest in the world, across different currencies and investment instruments, including in emerging markets, Chinese central bank governor Zhou Xiaochuan said on Friday.

His remarks sent the dollar tumbling for a second day and fueled a growing debate about how China should best use its fast-growing reserves, which are about 70 percent in U.S. debt securities, bankers estimate.

"(Diversification) includes currencies, investment instruments, including emerging markets," Zhou told Reuters on Friday on the sidelines of a monetary conference.

Asked about selling U.S. dollars, he said: "We do not have any new preparations for selling any currencies." He said gold sales were not under consideration.

Changes in China's massive stockpile of money are being closely watched because it could ripple through financial markets worldwide, risking a steep dollar fall if U.S. debt floods onto the market, which could push up U.S. interest rates and slow global growth.

These fears caused the U.S. dollar to hit a 2-1/2 month low against the euro, while gold prices rose to fresh two-month highs but emerging market debt was largely unaffected.

In comments published on Friday, Chinese researchers said the country's huge pile of reserves was a double-edged sword. On the one hand it increased foreign confidence in China's economic stability and laid the foundation for China to make the yuan fully convertible in future.

On the other hand the reserves symbolized China's growing economic imbalances, including a record trade surplus, and so helped spark friction with its main trading partners.

It also exposed China to more market risks, generated upward pressure on the yuan, raised the risk of inflation and made it harder for the central bank to conduct monetary policy, they said.

"China now faces a dilemma. It either keeps the exchange rate stable or sacrifices sound economic growth," Dou Erxiang, a researcher at Peking University, told the official newspaper Financial News.

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