China's huge stockpile of foreign exchange reserves, the world's largest, have become excessive and the government must diversify investments using the reserves, Zhou Xiaochuan, governor of the People's Bank of China, said in comments published on Tuesday.

The country's foreign exchange reserves swelled by nearly $200 billion in the first quarter of this year to more than $3 trillion, indicating hefty capital inflows, and the government has so far focused on investing mainly in US dollar assets, including US Treasures.

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"Foreign exchange reserves have exceeded our country's rational demand, and too much accumulation has caused excessive liquidity in our markets, adding to the pressure of the central bank's sterilization," Zhou was quoted by the official Shanghai Securities News as saying.

"The State Council has required a cut in excessive accumulation and good management of the funds accumulated, including diversification of investments," Zhou was quoted as telling a forum at Tsinghua University in Beijing.

The PBOC injects huge amounts of yuan into the banking system to buy the foreign currencies from commercial banks.

The central bank then soaks up the excess yuan in the system via open-market operations and higher bank deposit reserve requirements. This is to prevent the money from flowing into the economy and fuelling inflation.

The newspaper did not quote Zhou as giving any details on the diversification of foreign exchange reserve use, although Chinese economists have urged the government to buy more assets in other currencies, such as euro and yen, as well as to invest in strategic goods such as oil and non-ferrous metals.

Commenting on other aspects of China's economy, Zhou was quoted as saying that the central government was considering letting local authorities issue municipal bonds for the first time as the main avenue for future financing of regional infrastructure construction.

Local governments have so far relied mainly on sales of land for such financing, supported by quasi-treasury bonds issued by the central government on their behalf or special funds.

That has helped inflate China's real estate prices and caused strong resistance from regional authorities to steps from the central government to cool the property market, among other problems.