Japan's efforts to weaken the yen may cause China some pain as it seeks to diversify its foreign exchange reserves into Japanese debt but Beijing has little option but to press on with the investment. China has long said it wants to diversify its foreign exchange reserves, which are mainly in dollars.
With the US economy facing a slowdown and the eurozone having sovereign debt problems, Chinese reserve managers have little choice but to keep investing in Japanese assets even if Tokyo, which intervened last week to weaken the yen, acts again. "Of course, the Chinese will have to take some pain if the yen starts weakening," said Simon Derrick, head of currency research at Bank of New York Mellon. "But even if they do, I think this process of diversifying into yen assets will continue, because they want to put more eggs in their basket."
Recent trends suggest China is buying more yen assets and moving away from US debt. Data shows Chinese net buying of Japanese debt has surpassed 1.7 trillion yen ($20.14 billion) this year, easily beating its record of 255.7 billion yen in 2005.
At the same time, China has cut back slightly its vast holdings of US Treasuries, from $894.8 billion at the start of the year to $843.7 billion in June, though Beijing remains the biggest single holder of US government debt.
China's forex reserves, the world's largest at $2.45 trillion, are 65 percent in dollars, 26 percent in euros, 5 percent in sterling and 3 percent in yen.
With the yen appreciating more than 9 percent this year, the shift away from US debt to Japanese debt will have generated good returns but some of the shine could come off as the Japanese authorities try to drive the yen lower.
Japan spent a estimated record $23 billion on Septemeber 15 to weaken the yen, toppling it from 15-year highs against the dollar. The Japanese warned of more unilateral intervention, triggering speculation the yen could cede more ground.
After Japan's last intervention, in 2004, the yen fell to a low of 121.40 yen in December from 101.67 yen in January 2005.
"I don't think that the Chinese are in it with a currency view," said Derek Halpenny, European Head of Global Currency Research at BTM-UFJ in London. "They will continue buying Japanese debt even if the yen were to change course."
China bought a net 640.8 billion yen in short-term Japanese bills in July. In contrast, Chinese investors were net sellers of medium- to long-term Japanese bonds. "The Chinese are buying Japanese money market instruments and short term debt simply because of the low opportunity costs and the fact they need to deploy the cash from the sale from their US Treasuries holdings somewhere," Halpenny said.
He said the cost of holding Japanese three-month t-bills worked out to 11 basis points while the cost for holding a similar tenor US instrument was around 15 basis points.
But China's move to increase holdings in Japanese debt has stirred concerns among Japanese policymakers. Japan's Finance Minister Yoshihiko Noda said it was not known why China was buying more short-term Japanese government securities but Tokyo was keeping in contact with Chinese authorities to confirm what was behind the move.
Despite the rhetoric and political tension, including over a Chinese trawler captain at the heart of a territorial row between the two countries, analysts say growing trade ties between China and Japan and worries about the US economy will keep the Chinese interested.