Zhao Xijun, vice-president of the School of Finance at Renmin (People's University of China enunciates the rapidly growing foreign exchange (Forex) reserve with an extended scale in China over recent years and opportunities and challenges it has brought to the Chinese economy in an exclusive interview with a People's Daily Overseas Edition reporter.

Q. What opportunities a huge Forex reserve has brought to China?

A. China's Forex reserve, ranked the first globally, has played an immense role in increasing the nations's comprehensive national strength and effecting the rapid growth of Chinese economy. The favorable balance of payment and increased Forex reserves have often been regarded as salient hallmarks for the comprehensive national strength of a nation. I deem that a huge Forex reserve can bring us opportunities in five aspects, which deserves people's serious and conscientious considerations. First, upgrading China's payment capacity and balance of income and expenses to a great extent. Secondly, greatly increasing the strength to stabilize the exchange rate of Renminbi (RMB). Thirdly, providing a solid basis for pushing forward the opening of China's capital account and the free change of RMB into foreign currency. Fourthly, tremendously lifting the capacity of the national economy to resist risks, including that of resisting the risks from external impacts and fluctuations of domestic and overseas economies and, fifthly, upgrading its impact on the international monetary market.

Q. The issue of Chinese currency is almost solely based on US dollars, and what impact does it have on China's independent monetary policy?

A. Due to a rapid increase in the amount of Forex reserve over recent years, the total increase value of Forex assets reached up to 66.4196 billion US dollars in five years from 2000 to 2005.

China has gradually lost its independence with the implementation of its monetary policy as the issue of its own currency has increasingly been based on the US dollars and the excessive growth in the Forex reserve has added both difficulties and complexity in the execution of the money policy. Moreover, costs and difficulties have also multiplied for the operation of the monetary policy. In order to dispel the impact inflicted by increased Forex reserve on money supply, the central bank has to withdraw RMB from circulation on the RMB open market to offset impact on the monetary policy. The central bank should resort to regular "hedging" operation methods to withdraw capital on the money market to reduce its market supply.

Besides, a marked increase in Forex reserve restricts the use of other central bank regulatory policy measures. When China's economy is slightly overheated at present, the central bank has adopted a common macro-regulatory measure for interest-rate growth, but the government is extremely cautious with regard to interest rate increase, which constitutes a major factor for the pressure on the appreciation of RMB. So swell Forex reserve has also inhibited the central bank from raising interest rate to regulate the economy.

Q. What new challenges has huge Forex reserve brought about?

A. New challenges are also manifested in the ensuing four aspects apart from the impact to exert on the independence of the monetary policy.

I. Excess liquidity lashing macro-economy. A marked increase in China's Forex reserve also gives rise to the problem relating to the excess liquidity of RMB. To date, excess liquidity has become a protruding structural contradiction in the country's banking operation, a thorny issue for financial decision making departments.

II. Aggravating the imbalance of economic structures. The excessive growth in Forex reserves results in the imbalanced driving power structure of economic development. The drastic increase in Forex reserve has been brought about at an economic backdrop of decline demands of domestic residents and an inefficient impact of consumption on economic growth. So it has been paid dearly with the export of resources-turned primary products and at the high expense of both resources and environment.

III. Giving rise to financial cost and opportunity costs. Owing to a relatively big proportion of US dollars in China's Forex reserve, the devaluation of the dollar and a drop in the yield rate of US bonds, China's Forex reserve assets will shrink and its earning rate will also decline. Meanwhile, large quantities of Forex reserve will also bring fairly high opportunity costs.

IV. Imposing a pressure on the appreciation of RMB. An increased Forex reserve is surely accompanied with a steady rise in the appreciation of the native currency on China's Forex market, and a super-scale Forex reserve will certainly add pressures to the appreciation of RMB. The marked rise in China's Forex reserve indicates the supply of foreign currency exceeding its demand on the domestic and foreign currency market.

Q. What responsive measures should the Chinese government take to cope with these challenges?

A. The control of Forex reserve is not the eventual objective, and the settlement of the issue with increased Forex reserve lies in the resolution of payments imbalance.

Firstly, to further advance the reform on the administration of Forex reserves. The crux of the matter in stepping up reforms on the administration of Forex reserve lies in how to open the capital account steadily and orderly. In compliance with its specific national conditions, China should first ease the control of outflow capital and proceed to relax the control of inflow capital. Moreover, on the tactics of introducing foreign direct investment, it is essential for China to readjust its policy on attracting capital from overseas so as to upgrade both quality and efficiency of the foreign direct investment, and reduce the amount of incoming overseas capital in a bid to alleviate the pressure on Forex reserve.

Secondly, to rationally improve the situation with China's external trade by cutting huge trade surplus step by step and continuously optimize trade revenue and expenditure structure. Meanwhile, the export of products that involve high pollution and great energy consumption will be restricted to create more favorable conditions for innovation and guide and steer the prioritization of the export goods mix.

Finally, to optimize the management of reserve assets. At present, how to use Forex reserve effectively and efficiently is a matter of urgency with a sophisticated service capability. Substantial discussions can be held on how to use Forex reserves for the selective purchase of material products, to have more imports to reduce the trade surplus to ease pressure on exchange settlement, to use part of the reserve to buy high-tech products or strategic resources.

After the entry of foreign funded firms into China, Forex reserve can also be used to invest in their share options to beef up the regulation of some industries relating to the national economic security sectors. Moreover, the use of Forex reserve on the popularization of education, medical and social security networks, environmental production service and other related public utilities can also be taken into account. What should be underscored particularly once again is high attention that should be attached to the legitimacy and possible risks in the use of Forex reserve.

By People's Daily Online