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Home >> Opinion
UPDATED: 17:19, April 10, 2006
Is the largest forex holding a blessing or headache?
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The People's Republic of China experienced strapped days after it was founded. Now should China have to be worried about its massive forex reserve which is still scaling up sharply? The Overseas Edition of the People's Daily published on April.7 an article by Jiang Yong, an expert on economic security with China Institutes of Contemporary International Relations, to look into the question.

The upsurging foreign exchange reserve have prompted China in recent years to shift its policy to ease the pressure of the robust upward momentum from its long-held preference for "as much as possible" forex holding and the idea of "thrift and revenue increase".

On April 5, the State Administration of Foreign Exchanges (SAFE) confirmed that by the end of February China's forex reserves had hit 853.7 billion US dollars and surpassed Japan to be the No. 1 in the world although its GDP still half of that of Japan.

China has realized that its forex reserves is more than "appropriate" in terms of the imports payment capacity, short-term debt settlement, and the ratio of forex to GDP. The excessive and continuous soaring forex reserve is an indicator of unbalanced international payment, which in turn implies and deteriorates the unbalance of the domestic economy. It also hinders the efficiency in monetary policy implementation and distorts the resources allocation.

The rising foreign exchange cost not only needs tremendous renewable human resources, but also tremendous unrenewable natural and environmental resources.

The prospect of riskier forex reserve market and weaker US dollar has been increasingly underpinned by the US trade and fiscal deficit. That will lead to shrinking US dollar denominated assets.

In the light of this, China has taken a series of new forex management measures in a bid to slow down the forex growth to achieve balanced international payment. As a result, the trade surplus has played a less important role in the forex reserve growth than it used to. In 1999, contribution of the trade surplus was 300 percent while it was plummeted to 48.7 percent in 2005. Over the four years from 2002 to 2005, China recorded 189.9 billion US dollars of trade surplus which was only 29.2 percent of the country's additional forex reserve of 650.7 billion US dollars.

The experience of Japan and Russia has proven that an adjustment of the mix of forex reserves, more gold and strategic materials holdings, foreign debts repayment in advance, moderate scale management, and the discretion of forex settlement are effective precautions against forex reserve risks.

It is also necessary to control the rise of forex reserves. It is of consideration to slow down the rise of forex reserves, curb the influx of hot money, and adopt new forex management regime to avoid turning all favorable balance of the international payment into official forex reserves.

China does not take the forex reserve growth as a reflection of economic growth. There are two sources of China's forex reserve. One is from its world trade surplus which is generated by the competitiveness of "made in China" and represents China's economic power to some extent. That is to its credit.

The other is the influx of speculative capital driven by the expectation for "RMB appreciation" since 2002. That part is to the country's debits and does not reflect the country's economic strength. In recent years the debit entry has been higher than the credit entry in terms of the total amount and the growth. Therefore, the soaring forex reserve is the result of the further openness of China's economy and the hot money on the speculation of the prospect of stronger yuan.

China needs massive forex reserve to safeguard the reputation of the nation enterprises and consolidate in China's reform and opening-up endeavor both nationally and internationally. China needs massive forex reserves to expand the foreign trade, attract foreign investment, reduce the financing costs of domestic enterprises.

Massive forex reserves help China maintain the international payment account, secure a stable financial system, deal with contingencies and prevent and resolve financial risks. Massive forex reserves also facilitate China's efforts on promoting the regional and international economic exchanges and financial cooperation to take its responsibility of a big nation.

By People's Daily Online

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