MoF’s portfolio flow data show that China bought roughly JPY 1.3 trn worth of Japanese bonds and notes this April (See Figure 1). China’s bond investment had previously surpassed JPY 100bn per month, but it appears to have accelerated recently, touching 200bn in March before hitting a historic high in April.
This appears to contrast flows in short-term securities. The MoF’s monthly data shows that China sold (or redeemed) a total of roughly 5.1trn in short-term securities from last August to April. So it possible that China was simply rotating from short-term to long-term securities. However, the apparent selling of short-term securities may be exaggerated and could simply reflect an idiosyncrasy in the data collection. The MoF data for inward investment is categorized by the principle of institutions’ nationality rather than ‘beneficial’ ownership. For example, if China buys a JGB through a UK institution, the MOF classifies this as a UK purchase.
On the other hand, data from the BoJ’s annual regional direct investment position, regional portfolio investment and financial derivatives position surveys is based on the principle of creditors/debtors. This data shows China’s portfolio investment in Japan surged to roughly JPY 13 trn in 2010, compared to the previous JPY 3-4trn. Equity and bond investment increased by 3.3trn and 7.1trn respectively, while short-term securities investment increased by JPY 6.3trn. Given this trend, we are inclined to believe that the apparent increase in appetite for long-term securities reflects a real pick-up, while the short-term securities ‘selling’ evident in the MoF data is not representative.
Diversification away from USD is said to a reason why China has bought Japanese assets. Given the low yield on Japanese denominated assets it is unlikely that Japan will become a primary target for China. However, there is some reason to believe that further investment may be in store because the decision to buy Japanese (and other regional) assets may partly be political. In buying regional assets, China exerts upward pressure on regional currencies and may be seeking to side-step the ‘coordination’ issue of currency appreciation vs. the USD.
To be sure, China invested in JGBs by roughly JPY 7.1 trn last year. While China’s foreign reserves increased from USD 2,399.1 bn to USD 2.847.3 bn, so roughly 20% of these additional foreign reserves was allocated to JGBs. As a result, our calculation suggests that JPY denominated shares in China’s foreign reserve increased to around 5%. This level is higher than the 3.9% JPY share in the total foreign reserves shown in IMF’s data in 2010. In other words, China does not seem to be underweight Japanese securities to the degree that it was before.
China may exchange its Japanese short-term securities for JGBs. However, given PBOC’s balance sheet, we do not believe that China would invest in JPY denominated assets to “overweight” level. In other words, we do not expect that China would invest in JGBs as aggressively as we saw on the previous year even if some additional buying features. On the other hand, we believe that China’s underlying reasons to invest in JGB would be to cope with flood of reserves. Altogether, the ratio of Chinese buying of Japanese assets in total reserves is expected to be smaller, but the uptrend in foreign reserves itself may represent a potential JPY positive.