BEIJING USES FOREX AS TOOL OF DIPLOMACY

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The secretive government agency that supervises China's foreign exchange reserves used part of its funds to help convince Costa Rica to sever ties with Taiwan and establish relations with Beijing last year, according to documents obtained by the Financial Times.

The purchase of US-denominated Costa Rican government bonds by China's State Administration of Foreign Exchange (Safe) is the clearest proof yet Beijing regards its $1,800bn in foreign reserves – the world's largest – as a tool to advance its foreign policy goals, as well as a potential source of income.

“This is the first smoking gun that proves China uses its foreign exchange reserves for political purposes,” said Kerry Brown, senior fellow with the Asia programme at Chatham House in London. “It raises questions about some of Safe's other investments and will worry politicians and business people in places where Safe is taking stakes in high-profile companies.”

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Encouraging the handful of countries that still recognise Taipei as the legitimate representative of the Chinese people to switch their allegiance is a key foreign policy objective for Beijing, which regards Taiwan as a renegade province.

China and Taiwan have for years used aid payments, infrastructure projects, and the like as incentives for small countries like Costa Rica to take their side.

But Safe's international profile is relatively new. In the past year, it has used a Hong Kong subsidiary to buy small stakes in publicly listed companies including BP, Total of France and at least three Australian banks.

Safe does not publicly disclose its investments and has refused in the past even to acknowledge the existence of its offshore subsidiaries. Safe and three of its offshore subsidiaries refused repeated requests for comment.

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In January this year Safe bought $150m in US dollar- denominated bonds from the government of Costa Rica as part of an agreement signed last year under which the Central American nation cut diplomatic ties with Taiwan (after 63 years) and established relations with the People's Republic of China.

The agreement, signed on June 1 2007 by Yang Jiechi, China's foreign minister, and Bruno Stagno Ugarte, foreign minister of Costa Rica, explicitly links the foreign policy switch to China's purchase of $300m in government bonds and a grant of $130m.

In an exchange of letters from January this year between Fang Shangpu, Safe's deputy administrator, and Costa Rica's finance minister, Safe promised to buy government bonds under the terms of the 2007 agreement, but included a clause demanding Costa Rica take “necessary measures to prevent the disclosure of the financial terms of this operation and of Safe as a purchaser of these bonds to the public.”

Costa Rican diplomats advised against keeping the terms secret, but the Chinese insisted, said people familiar with the matter.