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    China Business
     Nov 17, 2006
China's $1 trillion question

BEIJING - China's more than US$1 trillion foreign-exchange reserve, while showing the rise of China as a world power, is not money that can be spent casually.

Domestic and foreign experts have suggested many ways of managing this sum and some have suggested spending some of it.

Some experts have suggested that China use the money to import high-tech equipment, while others have recommended

spending it on improving domestic education, medical care and environmental protection. In general, these people held that it is better to spend money in the above areas than simply to invest it in US Treasury bonds.

These suggestions seem reasonable, but this reserve should be used cautiously, officials say.

According to China's existing foreign-exchange regime, enterprises and individuals are not permitted to hold foreign currency. They must sell it to banks and consume in the Chinese currency, while China's central bank must issue base money to buy the inflowing foreign exchange in various forms. This means that the foreign-exchange reserve is bought by the central People's Bank of China (PBOC).

In fact, the foreign-exchange reserve is the same as the assets under the management of commercial banks. Moreover, to maintain the existing managed floating-exchange-rate regime, the PBOC must buy some foreign funds, including US dollars, to keep the yuan exchange rate floating in a reasonable range.

So although the foreign-exchange reserves are assets of the central bank, they are also liabilities.

Statistics show that the monthly foreign-exchange-occupied yuan amount has grown 30% since the beginning of this year, topping 8 trillion yuan (about $1 billion) by the end of September. The rising foreign-exchange-occupied yuan amount has induced China to supply more currency, which has increased inflation and reduced the scope for financial control.

As for the suggestion of replenishing social-security accounts or buying strategic oil reserves with the foreign-exchange reserve, Wu Xiaoling, vice governor of the PBOC, said this would amount to fiscal-overdraft behavior and is impossible. If other institutions want to use the reserve, they must spend yuan to buy it.

Some foreign scholars believe that the central bank can buy foreign assets such as US Treasury bonds or buy back some equities of large state-owned banks, but the PBOC cannot invest foreign-exchange reserve in policy projects.

Wu said the PBOC is responsible for the management of the reserve and must ensure its preservation and appreciation, adding that the investment in the state-owned commercial banks is a kind of direct investment of foreign-exchange-reserve assets.

She said she believes the foreign-exchange reserve in these commercial banks will appreciate by a wide margin after listing. If the reserve is consumed on the domestic market, the foreign exchanges will have to be settled twice and the currency will be put on to the market twice, which will directly cause inflation.

China must be cautious in using its $1 trillion foreign-exchange reserve. China's reserve had never surpassed $1 billion before 1979 and it was even reported as negative in some years.

With China's opening up, sustainable economic growth and development of foreign trade, the foreign-exchange reserve soared. Over the past 26 years, it has rocketed from zero to the current level of more than $1 trillion.

The foreign-exchange reserve climbed to $2.7 billion at the end of 1981 for the first time, breaking the $10 billion benchmark in 1990 with $11.09 billion, topping $100 billion at the end of 1996 by hitting $105.05 billion, reaching $212.1 billion at the end of 2001, $609.9 billion in 2004 and $818.9 billion at the end of 2005.

The reserve grew to $853.6 billion at the end of February this year, overtaking Japan's to become the world's largest foreign-exchange reserve. The amount is still rising.

(Asia Pulse/XIC)

China's mushrooming forex reserve (Sep 19, '06)


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