Exclusive: Asia holds its nose, keeps buying U.S. debt

TOKYO/MUMBAI Thu May 12, 2011 10:15am EDT

U.S. one hundred dollar notes in a file picture illustration. REUTERS/Lee Jae-Won

U.S. one hundred dollar notes in a file picture illustration.

Credit: Reuters/Lee Jae-Won

TOKYO/MUMBAI (Reuters) - Asia's reserve-rich nations see no viable option but to keep on purchasing U.S. government debt despite their uneasiness about Washington's fraught political battle over public spending.

Interviews with policymakers from several Asian countries -- including Japan and China, the two largest foreign holders of U.S. debt -- showed officials were concerned that U.S. lawmakers would fail to authorize additional government borrowing before a $14.3 trillion debt limit is reached.

But they still considered U.S. Treasury debt the safest bet, particularly with so much uncertainty surrounding Europe's sovereign debt situation.

None of the officials said investment plans would change right away, even if Congress does not raise the debt ceiling this week. The debt limit will probably be reached on Monday, and the Obama administration has warned of "catastrophic" consequences if the government cannot pay its bills.

"Our stance remains unchanged on foreign reserves management," Japan's Deputy Finance Minister, Fumihiko Igarashi, told Reuters.

"The U.S. is making the most of having the dollar as key reserve currency and such a situation would not change immediately.

"But nothing will last forever, as with any political and economic conditions," he added. "We will closely watch developments" in Congress.

Japan held $890.3 billion in U.S. Treasuries as of February, the most recent month for which U.S. Treasury data on foreign holdings are available, ranking behind only China on the list of the largest foreign creditors.

Igarashi said Japan should aim to diversify its reserves to reduce Treasuries exposure, perhaps by increasing gold holdings or raising the percentage invested in euro assets. But he acknowledged that a portfolio shift would be "quite difficult... because selling Treasuries would hurt our own assets."

His comments on diversifying reserves differ from the finance ministry's official line. Finance Minister Yoshihiko Noda last month described U.S. Treasuries as attractive products even as S&P warned that it could downgrade the U.S. credit rating unless Washington addressed its budget difficulties.

Politically appointed ministers tend to speak more freely than government bureaucrats and can at times diverge from the official line in their comments.

SAFETY FIRST

Reuters spoke with about a dozen senior policymakers across Asia, many of whom insisted on anonymity in order to speak more candidly about sensitive fiscal policies.

"There is no choice for us apart from investing in U.S. Treasuries," said an Indian central bank official with direct knowledge of external investments. "We don't think about profitability. For us, first comes safety, then liquidity and lastly returns."

About 55 to 60 percent of India's roughly $300 billion in foreign currency assets is invested in U.S. securities.

The Indian official said the euro zone was "uncertain" right now, making it a less attractive investment option. There was a lot of "confusion" over the fate of Greece, which may need more aid on top of last year's bailout, the official said.

The Federal Reserve, the U.S. central bank, held $1.44 trillion in Treasury debt as of May 4, exceeding even China's vast holdings. But the Fed is scheduled to wrap up a $600 billion bond-buying program next month, and some prominent investors have questioned who will step in -- particularly if Congress can't come up with a debt limit extension.

Laurence Lau, head of the Hong Kong office of China Investment Corp, told reporters that U.S. borrowing costs may rise once the Fed wraps up its buying binge, leading to small losses for debt holders. But he dismissed the idea that the United States would ever renege on its obligations.

"U.S. Treasuries are safe investments, and the U.S. government will pay back its debts, there is little concern about that," he said.

Even if Congress does not lift the debt ceiling this week, the Treasury Department has said it has some maneuvering room to fund the government until August 2. An increase of about $2 trillion is needed to ensure enough borrowing power through the November 2012 presidential election.

But failure to find a compromise would heighten concerns that Washington lacks the political will to address its fiscal troubles, both short- and long-term.

Bank of Thailand governor Prasarn Trairatvorakul said around half of Thai foreign reserves were invested in U.S. Bonds and the country aimed to reduce that proportion.

"we are worried, like other global investors, about the U.S. Debt issue," he told reporters in Bangkok on Thursday, referring to broad deficit issues and not just the debt ceiling fight.

Assets denominated in Chinese yuan were among the alternatives, he said.

For south Korea, which invests nearly two-thirds of its $300 billion in reserves in U.S. dollar assets, the debt ceiling debate was "increasing the uncertainty" over U.S. debt, said a senior official with direct knowledge of the country's foreign reserves management.

The official declined to comment on whether the Bank of Korea would increase or decrease its purchases of Treasuries if Congress failed to strike a debt ceiling deal.

(Additional reporting by Choonsik Yoo in Seoul, Zhou Xin and Kevin Yao in Beijing, and Kitiphong Thaicharoen in Bangkok; Writing by Emily Kaiser; Editing by Vidya Ranganathan)