Is China's Forex Reserve Surplus?

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Last updated at: (Beijing Time) Friday, August 01, 2003

Is China's Forex Reserve Surplus?

According to the latest data released by China's central bank, by the end of June 2003China's foreign exchange reserve had a surplus of US$ 346.5 billion, up 42.7 percent year on year, 8.5 percentage points higher than that of the same period last year. China reported an accumulative increase of US$ 60.1 billion in forex reserve from January to June this year, a rise of US$ 29.5 billion over the same period last year.

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Though affected by the outbreak of Severe Acute Respiratory Syndrome (SARS) in the first half of this year, China's foreign exchange reserve (hereinafter referred to as "forex reserve") demonstrated a momentum of fast growth. According to the latest data released by China's central bank, by the end of June 2003 the country's forex reserve had a surplus of US$ 346.5 billion, up 42.7 percent year on year, 8.5 percentage points higher than that of the same period last year. China reported an accumulative increase of US$ 60.1 billion in forex reserve from January to June this year, a rise of US$ 29.5 billion over the same period last year.

Many people didn't expect such a rapid forex reserve growth. As a developing country, China ranks second worldwide in terms of forex reserve. This has given rise to the following questions: How large a scale is appropriate for China's forex reserve? Is it excessive to have forex reserve exceeding US$ 300 billion?

Take a strategic view of forex reserve.

Deputy Directorl Qiu Xiaohua of the National Bureau of Statistics pointed out, "We should not look upon China's forex reserve merely from the angle of current economic resources, but instead, we should notice China's standing on the general pattern of the world, in the present link of development and in future development, China needs more forex reserves."

Qiu Xiaohua then expounded from three aspects the strategic significance of holding a large forex reserve. "To begin with, forex reserve is a solid material foundation for resisting international risk, without a large amount of foreex reserve, it would be more difficult for China to cope with some international challenges. Secondly, forex reserve serves as an important driving force for a more developed economy, playing a vital part in adjusting the structure, deepening the reform, upgrading technology and other fields. And thirdly, forex reserve is also an essential condition for the RMB currency to finally realize full convertibility. Without ample foreign exchange, it would be impossible for the RMB to go global."

Qiu Xiaohua noted that as the economy is becoming more and more international, China will unceasingly increase exports, open the market constantly and maintain a pattern of basic balance with a slight surplus in commodity import & export. Besides, China will hopefully acquire more foreign exchange by developing the service trade such as tourism, thereby further increasing China's forex reserve.

Li Zhenqin, a Chinese American expert engaging in financial credit consulting work, is worried that a huge forex reserve implies risks. "It is beyond doubt that China's enormous forex reserve plays a positive role in countering the influence exerted on China by the fluctuations of the international market, but from a different perspective, China, as a continental economy, still exercises a certain degree of foreign exchange control. It is really worth discussing whether it is necessary to keep such a huge forex reserve as emergency fund against bank run."

Li said bluntly, "I don't agree with those claiming that a huge forex reserve helps to enhance foreign investors' confidence. Both the absolute value of Japan's forex reserve and the proportion of Chinese Taiwan's forex reserve to its GDP are higher than those of the Chinese mainland. However, no data at hand indicate that the aforementioned regions have a strong appeal to foreign investors."

In Li's opinion, as a developing country China is in dire need of funds for development in various fields. It is of benefit to China's lasting political stability in future development if the forex reserve, after deducting those short-term or high-interest foreign loans, is converted into the RMB currency and then is invested in universal education, medical treatment, social security system, environmental protection as well as standardization, institutionalization and informationization of the national economy, finance and commerce.

Li also noted that, "Even so, if the above-said money can be used to pay off the treasury bonds issued by the government in previous years, such a big private fund will greatly propel China's economy forward."

How much foreign exchange does China need to reserve?

As a matter of fact, Chinese officials' attitude is crystal clear toward the question about whether US$300 billion-plus forex reserve is too much for China.

Guo Shuqing, director of the State Administration of Foreign Exchange (SAFE), voiced his explicit statement early at the 10th NPC and CPPCC sessions last March.

Guo held that there is no unified standard theoretically and practically concerning how large a scale of forex reserve is appropriate for a country. Generally speaking, when deciding on an appropriate level of forex reserve, countries should take all economic factors into consideration such as the scale and speed of the national economic development, opening degree of the economy, the situation of foreign trade development, capacity of foreign capital utilization and international financing as well as capability of national macroeconomic regulation and control.

According to Guo's analysis, since actual conditions of countries are varied, the levels of their forex reserves differ enormously. For instance, developed countries generally reserve less foreign exchange, for they have a stronger comprehensive power, and their domestic currency is an international reserve currency which can be used for direct foreign payment and has a floating exchange rate as well. In the case of developing countries, they have a relatively backward economic level and go short of foreign exchange resources, and their home currency is not convertible, they institute different degrees of exchange rate control, so the size of forex reserves in their possession is larger accordingly.

Guo added that the sustained growth of the forex reserve since the reform of foreign exchange system conforms to China's economic development level and international development trend and to the current foreign exchange administration system, especially the compulsory settlement of exchange and a controlled floating rate, as well as to the present economic management system.

"Of course, any economic behavior comprises certain costs and risks. But when weighing up the cost and benefit of forex reserve, we should make not only microeconomic but also macroeconomic accounts. Retaining forex reserve aims mainly to guarantee a balance of international payments and safeguard the security of the national economy as a whole."

Don't worry about an excess of forex reserve.

Guo's viewpoint, standing for the Chinese government, also receives support from world-renowned economists.

Robert Mundell, 1999 Nobel Laureate in Economics and professor at Columbia University, expressed the opinion that, although it is proper for China to control its forex reserve at around US$100 billion in accordance with conventional theory, China's special situation requires a much higher level of forex reserve than that under normal conditions. Considering that the domestic financial system is incomplete and the RMB is not yet convertible, China thus needs more forex reserve to serve as a powerful backing, in a bid to prevent venture capital from disturbing the economic stability and safeguard the financial security.

Mundell said there was no need to worry about the excess of China's forex reserve even though the present amount is more than the total of annual import value. "Of course," he said, there is also the need to artificially increase forex reserve in the future. Sufficient forex reserve means a very useful asset to the Chinese government and it will provide effective and convenient support for the future free convertibility of the RMB currency.

By PD Online Staff Zhu Lizhen

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