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Home >> Opinion
UPDATED: 17:29, January 18, 2007
What to do with US$1 trillion of forex reserves?
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Figures released by the People's Bank of China on January 15 show that at the end of December 2006, China's foreign exchange reserves totaled US$1.0663 trillion, an increase of 30.22 percent from 2005.

During the last two years, China's foreign exchange reserves have grown by US$200 billion annually. Last February, China overtook Japan as the country with the largest foreign exchange reserves in the world.

Along with the deepening of reform and opening up, China has reported sustained economic growth. The influx of foreign investment and the rapid development of foreign trade are the main reasons for the substantial increase in foreign exchange reserves. The inflow of speculative funds and the ballooning trade surplus has caused the US dollar to prevail in China. In normal circumstances, the excess of dollars would have pushed up the RMB exchange rate. To maintain the stability of the RMB, China's central bank has bought almost all the foreign exchange streaming into the country and managed these funds on its assets balance sheet. In this way all the foreign exchange became the country's foreign exchange reserves.

Too much?

"1 trillion is a big number, as well as a hot potato," said Ha Jiming, chief economist of the China International Capital Corporation.

In October last year, Chinese Premier Wen Jiabao said that the increase in foreign exchange reserves "enhanced China's comprehensive national strength, international payment capacity and its ability to resist risks." But he also acknowledged that the backflow of foreign exchange reserves to local financial systems exacerbated distortions in the economic structure.

There is a belief among developed countries that foreign exchange reserves should be able to pay for at least three to six months of imports. By the end of 2005, China's foreign exchange reserves were equal to 35 percent of its GDP. According to IMF standards, China's foreign exchange reserves are too large.

How should forex reserves be used?

The immense value of foreign exchange reserves has led to heated debate within China on how to manage and spend the funds.

According to Dr. Peng Xingyun, director of the Monetary Theory and Monetary Policy Research Office of the Institute of Finance under the Chinese Academy of Social Sciences, controversy mainly centers around three issues. Firstly, who should manage the funds �C the Ministry of Finance or the central bank? Secondly, how should the surplus spent �C on the purchase of goods or on financial products? Thirdly, should China adjust its foreign exchange reserve currency structure or continue to hold a large number of dollars? People are currently most interested in how the money should be spent.

Vice Premier Zeng Peiyan revealed in December last year that China will establish a mineral resource reserve system and increase the state's reserves of strategic resources by taking advantage of its huge foreign exchange reserves.

"We should be very careful about using our foreign exchange reserves," warned Peng. "They are the government's reserves in the first place and its foremost task is to maintain financial stability." There are also inherent risks in holding a large amount of foreign exchange reserves in dollars as investment. If the US government adjusts its macroeconomic policy, the dollar exchange rate will fluctuate and dollar assets held by China will automatically shrink. This in turn will reduce the US government's foreign debt burden to China. This phenomenon has occurred and will continue into the near future.

Can Chinese people enjoy the benefits?

"The surge in China's foreign exchange reserves reflects an unbalanced economic performance," explained Peng. The increase in foreign exchange reserves, as a result of the trade surplus, actually reveals an insufficiency in domestic demand. This lack of demand has also lead to an excessively high domestic savings rate compared to domestic investments. Moreover, the hike in foreign exchange reserves, resulting from the growth of foreign direct investment, shows that China has lost many good investment opportunities to foreigners. In addition, based on the expectation of RMB appreciation, an influx of ��hot' money from overseas has promoted an increase in foreign reserves, which has led to a rapid price-hike in real estate and other assets.

Peng Xingyun added that people don't really enjoy the benefits of the massive foreign exchange reserves. In fact, the growing foreign exchange reserves may even have an adverse impact on people's lives.

By People's Daily Online

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