RBA to Invest Foreign Currency Reserves in China, Lowe Says

Australia’s central bank plans to invest about 5 percent of its foreign currency reserves in China as it deepens ties with the world’s second-largest economy, Deputy Governor Philip Lowe said.

The decision “represents the first time that the RBA will have invested directly in a sovereign bond market of an Asian country other than Japan,” Lowe said in a speech today in Shanghai. “It reflects the broader economic relationship between China and Australia and our increasing financial ties.”

The announcement bolsters China’s efforts to raise the international profile of its currency without ending controls on capital movements. The move follows Australian Prime Minister Julia Gillard’s unveiling of direct trading between the yuan and the Aussie on a visit to China two weeks ago, tightening ties with her nation’s top trading partner.

“By opening their capital markets to central banks like Australia’s, China is taking a step in liberalization for foreign investors,” said Martin Whetton, an interest-rate strategist at Nomura Holdings Inc. in Sydney. “Given the strong economic ties between the two nations, Australia was an obvious candidate to be allowed to make this investment. The bigger question will be if this is followed by investments from other central banks.”

The Reserve Bank of Australia will join central banks from Thailand, South Korea and Hong Kong in seeking a quota to buy Chinese assets. The RBA held foreign currency assets of A$38.25 billion ($39.2 billion) as of March, according to its website.

‘Important Milestone’

The move is “another important milestone in deepening our financial and economic linkages with China,” Australia’s Treasurer Wayne Swan said in an emailed statement. “Strong financial linkages between our economies will ensure that Australia is even better positioned to benefit from the shift in global economic growth towards Asia.”

Australia’s economy has been boosted by a resource investment boom to meet commodity demand from developing nations including China, its largest trading partner.

The move reflects “greater diversity of our investments” and will help the RBA’s understanding of Chinese markets, Lowe said today. China’s central bank has approved an initial investment quota, he said. The Australian dollar became the third major currency to directly trade with the yuan on April 10, after the greenback and Japan’s yen.

Lowe, responding to audience questions, said the RBA plans to invest in onshore government securities and do so by the end of the year.

Biggest Trader

Asia’s largest economy took about a third of Australia’s exports in February and is its major customer for iron ore and coal exports. Trade in goods and services between the two nations was valued at A$127.8 billion in the year to June 30, 2012, Australian government figures show.

Chinese investment in Australia has risen more than five-fold since 2006 and reached about A$20 billion at the end of 2011, while Australian investment in China stood at about A$17 billion in 2011, Lowe said, adding the data probably understate the size as some funds are channeled through financial hubs like Hong Kong.

“A significant share of the growth in Chinese investment in Australia thus far has been foreign direct investment,” Lowe said. “This has been largely in the resources sector, although recently there has been some diversification, including into the services and real estate sectors.”

High Dollar

Australia’s dollar averaged $1.0381 in the past two years, compared with 71.3 U.S. cents in the prior two decades, spurred by near-zero interest rates in the U.S. and Japan and the investment boom. Lowe, comparing his nation’s financial system overhaul of the 1980s with the challenges ahead for China, said free markets can still raise questions for policy makers.

“One current example of this is related to the very high value of the Australian dollar, which is clearly making for difficult conditions in certain parts of the Australian economy,” he said. “The quantitative easing that has taken place in a number of countries is having a significant effect on exchange rates of freely floating currencies, and this is having ramifications for monetary policy in these economies.”

The RBA has held the cash rate at 3 percent this year after reducing borrowing costs in six steps for a total of 1.75 percentage points in the 14 months through December. Policy makers are trying to buoy industries outside of mining and offset the drag on the economy from the strength of the currency.

Gillard, in an April 22 interview refrained from criticizing the exchange rate of China. Asked whether the yuan was overvalued, the prime minister said that “I won’t be specifying what level any one currency should be at, but philosophically we do look for freer-trading currencies.”

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