China Continues to Cut US Debt for Yuan's SDR Entry

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China continued to cut its holdings in US Treasury securities in July, which experts mainly attributed to preparations for the yuan's inclusion in the International Monetary Fund's (IMF) Special Drawing Rights (SDR), effective October 1.

China currently held about $1.22 trillion worth of US Treasury securities as of the end of July, its lowest level since January 2013, down $22 billion from the previous month, according to the US Treasury Department's monthly Treasury International Capital (TIC) report issued on Friday.

While it was the second consecutive month when China's holdings of US Treasury securities declined, the nation remained the biggest overseas holder of US debt in the month.

The TIC report also showed that overall foreign holdings of US Treasury securities fell to $6.25 trillion, down from $6.28 trillion in June. In the same month, Japan, the second-largest US creditor, increased its holdings to $1.15 trillion, while the UK, the eighth-largest foreign holder, slashed its holdings by $22.8 billion. Other major countries that cut their holdings of US debt include Saudi Arabia, Russia, Canada, Singapore, Germany and Norway.

Tu Yonghong, director of the International Monetary Institute at Renmin University of China, said given the yuan's official inclusion in the SDR in October, the country may have made certain adjustments to its foreign exchange reserves, a major factor behind the July reduction in Chinese holdings of US Treasury securities.

"After the yuan's official inclusion, some central banks may increase their yuan portfolio to diversify their foreign exchange reserves, thus pointing to the increased supply of US dollars for China. In this sense, it is necessary for the country to make some preparations, or advanced structural adjustments to its foreign exchange reserves," Tu told the Global Times on Sunday.

Various financial institutions have given their estimates on the size of global reserves that will switch to Chinese assets after the yuan becomes a reserve currency.

Morgan Stanley previously expected global inflows of up to $2 trillion over 10 years, with most coming from central banks, while Bank of America Merrill Lynch estimated yuan demand to be worth $35 billion, according to a CNBC report in November 2015.

Need to unload

China Merchants Bank analyst Liu Dongliang said this may be because China has used its foreign reserves to support the yuan.

"Considering the currency's official inclusion in the SDR, the move will also serve to stabilize the yuan and help the currency smoothly endure the transition period," Liu told the Global Times.

Another reason is because China's central bank is stepping up efforts to strike a balance in the country's foreign exchange reserves, as an increasing number of Chinese enterprises are going global and investing abroad, Liu noted.

Industrial Bank chief economist Lu Zhengwei said since market expectations for a September increase in the US Federal Reserve's benchmark interest rates is quite low, the dollar is likely to face more pressure, thus justifying the central bank's decision to unload US debt.

"Quite a number of factors could explain the result … and there is no need to over-interpret the implications of a monthly change," Tu said.

She also pointed out that China's foreign exchange reserves, which have dropped from a peak of nearly $4 trillion in 2014, remain the world's largest.

"More than a quarter of China's cross-border trade is settled using the renminbi, and after the yuan is officially included in the SDR, more countries and regions will accept the yuan as the settlement currency in trade with China," Tu explained. "Thus, we need to gradually lower the huge amount of foreign reserves."


Source

China is selling US debt because they are broke and need to liquefy some of their reserves to prop up their economy. Their inclusion as a small component (8%) in the SDR basket will neither increase the usage of the Renminbi for payments, nor make it suddenly a major reserve currency.