China has allowed the yuan to fall 0.16 percent this year, after it gained every year since a peg against the dollar was scrapped in July 2005

China’s foreign-exchange reserves, the world’s biggest, had their smallest gain in eight years as exports slumped and the slowing economy deterred investment from abroad.

China’s first-quarter trade surplus shrank 45 percent from the previous three months and foreign direct investment tumbled as the global recession choked off demand. Slower growth in the reserves may limit Chinese purchases of US Treasuries just as the Obama administration seeks to sell record amounts of debt to fund a $787-billion stimulus package.

“The trend of slower expansion in reserves will continue throughout the rest of this year because it will be hard for exports to recover,” said Xing Ziqiang, an economist in Beijing at China International Capital Corp. “Smaller increases in reserves certainly mean less demand for US debt.”

The currency reserves plunged by $32.6 billion in January, the biggest monthly decline since Bloomberg started compiling data in 1996. The holdings shrank by $1.4 billon in February and expanded $41.7 billion in March.

Treasuries, euro

Saturday’s numbers compare with a record $154 billion gain in the first quarter of last year, when China’s currency, the yuan, was appreciating against the dollar and the economy was growing at a faster pace, encouraging inflows of capital. Economic growth slowed to 6.8 percent in the fourth quarter, the weakest in seven years.

China has allowed the yuan to fall 0.16 percent this year, after it gained every year since a peg against the dollar was scrapped in July 2005. The yuan closed at 6.8336 per dollar in Shanghai on Friday, according to the China Foreign Exchange Trade System.

The size of the reserves is affected by trade, investment flows and currency movements that determine the valuation of the nation’s non-dollar assets.

The declines in January and February were mostly due to falling Treasury returns and a weaker euro, according to China International Capital’s Xing. Merrill Lynch & Co.’s US Treasury Master index fell 0.5 percent in February, after a 3.1 percent decline in January. The euro dropped 8.3 percent against the dollar in January and 1.1 percent in February.

Wen’s concern

The US has been the biggest investment destination for the reserves. China’s Treasury holdings climbed 52 percent in 2008 and now stand at about $740 billion, according to US government data.

Premier Wen Jiabao said on March 13 that he was “worried” about the safety of the nation’s holdings and called on the US “to guarantee the safety of China’s assets.” Central bank Governor Zhou Xiaochuan has proposed a new global currency to reduce reliance on the dollar.

Treasuries have declined this year partly on concern that the US government’s spending plans will spur inflation.

“Those governments that have foreign reserves, especially those holding Treasuries, should demand that the US links the purchases of Treasuries with inflation,” Zheng Xinli, deputy director at the policy research office of the ruling Party, said at a conference in Beijing Saturday. “If the dollar depreciates and there’s inflation, the US should pay more.”

Still, China has “no other choice” but to continue buying Treasuries, China International Capital’s Xing said.

Oil spending

Foreign direct investment in China fell 26 percent in the first two months and the trade surplus plunged to $4.8 billion in February, the least since 2006, before rebounding to $18.56 billion last month.

Spending by China on oil and other natural resources may also have prevented larger gains in the reserves.

As much as $50 billion may have flowed out of China this year, largely because of the nation’s deals to acquire natural resources, according to Wang Tao, an economist with UBS AG in Beijing.

Source: Bloomberg