Other countries are investing in China through state agencies, but Japan's investment is by far the biggest in the yuan. As a currency with limited convertibility, such bets are symbolic of the shift in global power toward China as the world's fastest-growing major economy.
Despite sometimes rancorous political ties between the two neighbors, Japan's economic fortunes are increasingly tied to China's economic growth and consumer demand.
China is already Japan's biggest trade partner and the two countries hold the world's biggest piles of foreign exchange reserves — $3.2 trillion in China and $1.3 trillion in Japan.
"For China, the move is linked to its efforts to internationalize the yuan — allowing foreign investments in its debt market will make the yuan more accepted internationally," said Zhang Yongjun, an economist at the China Centre for International Economic Exchanges, a government think tank.
Japan's finance minister, Jun Azumi, said on Tuesday that Japan had received permission from China to buy 65 billion yuan in Chinese government debt. He said Tokyo needed to carry out some administrative steps in coming months before purchases could begin.
"We feel this is an appropriate amount when considering our mutual goal of strengthening economic cooperation between Japan and China," Azumi told reporters.
Japan and China agreed at a summit in December to strengthen financial cooperation and that included increased use of the yuan and yen in bilateral trade as well as Tokyo's buying of Chinese government bonds.
The Japanese investment will be handled outside of China's Qualified Foreign Institutional Investor (QFII) program, a quota system and the primary channel for foreign portfolio investment, the Ministry of Finance in Tokyo said.
Japan is likely to buy a small amount of debt at first and then increase purchases while considering possible market impact when choosing the timing of the transactions, Azumi added.
"The market impact should be manageable because the amount isn't that large and the market for dollars is huge," said Junya Tanase, chief foreign exchange strategist at J.P. Morgan Bank in Tokyo.
"Still, this is significant for economic cooperation and reserves diversification. It's difficult to tell now, but it is possible for the amount of bond purchases to increase in the future."
Japanese purchases of Chinese bonds would also be a sign of credibility in Beijing's long-term efforts to elevate the yuan's status as an international currency. That effort so far has involved China's promotion of the yuan to settle trade.
Beijing has struck agreements with several nations from Malaysia to Belarus and Argentina on the use of the yuan in trade and other transactions. It has expanded a pilot program started in 2009 into a nationwide one allowing firms to settle their trade in yuan.
The result has been a relative surge in the use of the currency. More than 9 percent of China's total trade was settled in yuan in 2011, up from just 0.7 percent in 2010.
China said on Monday it would continue its purchases of Japanese government debt, but would reduce purchases when the yen is rising to avoid exacerbating the negative impact of a strong yen on exports. At 82.25 per dollar, the yen is off a record high reached last October of 75.31 yen, but corporate Japan is highly sensitive to the exchange rate.
Japan hopes cross-holdings of investments between China and Japan will improve economic cooperation and communication between the two countries. Japan may gain more insight into Chinese thinking on the yuan through the cross-holdings, a source in Japan said.
The risk for both China and Japan is that sudden big purchases of their debt could have a major impact on their respective markets, so communicating their investment intentions would be important.
China and Japan have been talking about diversifying their foreign assets, but Japan particularly has been at pains to reassure of its unwavering confidence in the US dollar, the globe's pre-eminent reserve currency.
Foreign investors can invest in China's stock and bond markets only through the QFII program. The government has so far granted $24.55 billion in such quotas to nearly 130 institutions.
Nigeria indicated in September it wanted to diversify up to 10 percent of its $34 billion in foreign exchange reserves into yuan and the Financial Times reported the same month that Malaysia had bought yuan-denominated bonds.
Japanese Prime Minister Yoshihiko Noda and his Chinese counterpart, Wen Jiabao, agreed at a meeting on Dec. 25 to support Japanese businesses issuing yuan bonds in Tokyo and other markets outside of China. Japan Bank for International Cooperation would also begin a pilot scheme for issuing yuan-denominated bonds in mainland China.
"Japan's buying of Chinese bonds will definitely help the process of yuan internationalization," said Li-Gang Liu, chief China economist at ANZ in Hong Kong.
"Increased buying by advanced countries of Chinese bonds will help boost confidence in yuan assets and speed up the process of yuan internationalization."
Few argue against the idea that the yuan will one day become a reserve currency. The World Bank expects China, which generated around $5.8 trillion in gross domestic product in 2010 compared with $14.5 trillion in the United States, to become the world's top economy before 2030.
But to be a reserve currency the yuan would need to become full convertible, analysts say. So far China has not indicated any timetable for achieving that although the central bank said on Monday it will encourage the value of the currency to be set by the market and step back from intervention "in an orderly manner".
