China can reduce its holdings of dollar assets, but should not "overdo" it as the country tries to adjust the structure of its dollar asset-dominated foreign exchange reserves, analysts said.

The country's foreign exchange reserves amounted to nearly US$2.4 trillion by the end of last year -- a third of the global total -- raising concerns that the massive scale of the holdings could backfire.

About 70 percent of the reserves are dollar assets, according to various estimates by scholars, and the high proportion means that once the dollar's value slumps, China will incur huge losses.

But it is equally difficult for China to dump its dollar assets because that could lead to a domino effect on other investors and cause depreciation of China's holdings.

"China is in a dilemma," said Dong Yuping, economist at the Chinese Academy of Social Sciences.

According to the latest US Treasury International Capital (TIC) data, China was a net seller of US Treasuries in December, cutting its holdings by US$34.2 billion to US$755.4 billion.

China's share of total outstanding short- and long-term US Treasury securities among foreign holders declined to 20.9 percent in December from 23 percent in mid-2009, yielding its position as the largest investor in US treasuries to Japan.

"The data suggest that China could be more actively diversifying its currency reserves away from US Treasuries," said Jing Ulrich, managing director and chairman of China Equities and Commodities, J.P. Morgan. "We expect the country might be marginally shifting some exposure to other currencies."

While it is not clear that the selling is part of a consistent strategy, the country should keep a "considerable" proportion of dollar assets in its foreign exchange reserves, said Sun Lijian, economist with the Fudan University.

"China should not overly reduce its dollar assets, given their high market liquidity," he said. Dollar assets are relatively easy to sell if China needs quick money to safeguard its financial stability, he said.

More than a decade after the 1997-98 Asian financial crisis, there are increasing suggestions that China use its growing reserves to buy resources, technologies and attract high-caliber professionals from abroad. While they are important, Sun said, China must have enough reserves available for protecting its financial stability.

Asia was dealt a heavy blow during the financial crisis when international speculators attacked the currencies of some economies which did not have adequate reserves, plunging them into a spiral of currency depreciation, economic contraction and social chaos.

Since then, Asian countries have paid great attention to increasing foreign exchange reserves; and now, they account for seven of the top 10 nations.

As China's reserves grow, however, concerns are also growing that they could invite speculative capital inflows, especially when the country's economic recovery is quicker than in other regions.

Once the capital flows out of the country, there will be shocks to the domestic market and the economy, Sun warned.

To address the problem, China must quicken its pace of balancing domestic demand and exports as it strives to stimulate consumption as a major engine of economic growth, said Dong.

(China Daily February 22, 2010)