$711 bln forex reserves, is that big?

Latest statistics from the People's Bank of China, the central bank, showed that by the end of last June the nation's foreign exchange reserves had exceeded 700 billion (US dollars, same below) to reach 711 billion, while the figure surpassed 600 billion just six months ago.

Why China's foreign exchange reserves grew rapidly

The rapid growth in foreign exchange reserves largely comes from the "double surplus" under both current and capital accounts, which have been maintained for quite a few years. In 2004, China's current account surplus stood around 70 billion, and that under capital and financial accounts were more than 100 billion. During the first half of this year, China's total export volume reached 342.34 billion, and import 302.69 billion, creating a trade surplus nearing 40 billion. In terms of foreign direct investment, the first half of this year saw 28.563 billion foreign funds in place.

However, these figures do not seem to provide sufficient logics to support the growth. According to He Dexu, a finance researcher from the Chinese Academy of Social Sciences, looser forex supply, interest spread between yuan and foreign currencies and expectation of RMB revaluation, have combined to get domestic institutional and individual forex holders more motivated to sell their forex at hand but less willing to hold their forex. Moreover, the possibility of so-called "hot money" influx through various channels in anticipation of a RMB revaluation should not be ruled out.

Keep a cool head on foreign exchange reserves

What is the reasonable scale of forex reserves? Some link it with import demands, saying that it should meet import needs of six months; some others hold that forex reserves should be no less than 100 percent of a country's short-term foreign debts. These two views produce a proper scale around 300 billion, much lower than the current level.

He Dexu, for his part, said this is a very sophisticated rhetorical and practical question, which cannot be answered by simply judging it "big" or "small". After the Asian Financial Crisis, the major functions of forex reserves have shifted to preventing monetary crisis, boosting domestic confidence on the country's currency and dealing with potential financial risks. As China is now faced with arduous financial reform tasks and great pressure against external risks, sufficient forex reserves are crucial for improving the country's solvency and RMB credibility and safeguarding national financial security.

A huge amount of forex reserves, however, is a double-edged sword. The most obvious is the challenge it poses to credit regulation. As the forex reserves built up, the central bank had to inject more and more RMB to buy them in, with the number topping 5 trillion yuan by the end of last year. The additional forex reserves of 101 billion reported during the first half of his year means a additional monetary base of more than 800 billion RMB yuan. To avoid inflation, the bank had to issue large amounts of bills as a hedge.

New approaches to forex reserves management

For a long time, He Dexu said, China has been focusing on expanding exports and restricting imports, and encouraging inflow yet restricting outflow of funds. Major adjustments have been made in this regard but they need time to take effect.

The soaring reserves demand more efficient and effective management and operation of forex by related authorities, said He. Now our forex reserves are dominated by US dollars, such a structure is quite risky and must be optimized to maintain and increase the value of our forex assets.

The reserves would possibly continue to rise, He predicted. From a long-time view, we must continue reforms, balance capital flow and set up market and regulatory systems to manage international payments. The key is to push forward reforms in RMB exchange rate mechanism in an active and cautious manner so as to keep it basically stable at a rational and balanced level.

By People's Daily Online