China should press ahead in diversifying its foreign exchange reserves to reduce the impact of the turbulence hitting the US economy, but the immediate effect of any default or downgrading in Washington would be unavoidable, analysts said.
As US lawmakers came close to a last-minute $3 trillion deal on Sunday to raise the US borrowing limit, China, its largest debt owner, is being warned over the potential effects regardless of the outcome of the wrangling and urged to reform its current foreign reserve policy as a way to minimize its economic vulnerability.
Though China trimmed its holdings of US treasury debt in March for the fifth straight month to $1.145 trillion, it remains its largest debt owner, according to statistics from the US Treasury Department in May.
Xiao Lian, a researcher at the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, told the Global Times that no matter how the US balances its debt ceilings, the damage has already been done to China.
“If the debt ceiling is pushed up, it will only ease the temporary crisis with the US government putting more dollars into circulation, which would lead to depreciation of the US dollar. China’s holdings would then shrink. If the US doesn’t raise the ceiling, there won’t be any interest for China,” Xiao said.
There seemed to be a limited number of ways out of the crisis, but reducing holdings of US debts was a long-term strategy, he said.
“China’s economy relies a great deal on the international market. If the US market shakes under a new crisis, it will deal a huge blow to China’s export business. And depreciation of the dollar will mean a new round of price hikes, which will increase pressure of inflation,” Chen Fengying, director of the World Economy Institute of China’s Institute of Contemporary International Relations, told the Xinhua News Agency.
The Ministry of Industry and Information Technology acknowledged on July 22 that small- and medium-sized enterprises (SMEs) faced serious financing difficulties after the government tightened liquidity, but rejected claims of a wave of SME bankruptcies.
Tan Yaling, head of the China Forex Investment Research Institute, said she believed the risks China faces as the US’ largest debt owner have been overestimated.
“As long as the dominating status of the US dollar in the world’s foreign exchange market doesn’t change, China won’t face an immediate huge impact,” Tan told the Global Times.
“And there’s little alternative even if the US dollar were at risk,” she conceded.
Tan said what China needs to do now to minimize the risks is reform the country’s foreign currency reserve holdings, harnessing market forces in the trading of foreign exchange.
A Xinhua commentary said last week the world had once again been “kidnapped” by US domestic politics and blasts such “political brinkmanship” in Washington as “dangerously irresponsible.”
“It risks, among other consequences, strangling the still fragile economic recovery of not only the US but also the world as a whole. … Meanwhile, even if the US and the world economy do ride out the current game of brinkmanship relatively unscathed, Washington needs to conduct an in-depth self-examination,” the commentary wrote.
Some progress was reported on a tentative agreement on raising the federal government’s debt limit.
Senate Republican leader Mitch McConnell told CNN Sunday morning that the US is not going to default.
“We’re very close to a deal,” McConnell said.
He said that both parties were working on a $3 trillion package, and some conservative Republican members wanted a balanced budget amendment to the Constitution to be included in the deal.
Leaders from both parties are discussing the compromise plan “in a constructive way,” Democratic Senator Charles Schumer said on Sunday.
However, Schumer held that it was “premature” to say now that a deal has been reached, as there are many details to talk about before sealing an agreement, Schumer noted.
US President Barack Obama has brought the debate to the top of his political agenda.
In his weekly address on Saturday, he called for the two parties to act responsibly on behalf of US citizens to reach a final deal.
“It was done 18 times under president Ronald Reagan, seven times under George W. Bush. And it must be done again now,” Obama said. “It gives the United States of America the ability to keep its word. And it will let businesses and our economy breathe a sigh of relief.”
There are several precedents for the US government debt hitting the ceiling, but lawmakers eventually raised the limit and the country has not defaulted on its debt despite coming close in 1933, when Franklin Roosevelt was in office.
Agencies contributed to this story