China's foreign exchange reserves look set to hit the US$1
trillion mark at the end of this month or beginning of November.
But as the figure rises, so does the debate over how to best manage
it.
The reserves, already the world's biggest, surged to US$987.9
billion at the end of September, largely driven by a burgeoning
foreign trade surplus and massive inflow of foreign direct
investment (FDI).
In the first nine months of the year, FDI stood at US$42.59
billion, although this represented a 1.52 percent drop
year-on-year.
Reserves grew an average US$18.8 billion a month from January to
September, statistics from the central bank show.
"How to manage such a huge reserve is a big challenge," said Yi
Xianrong, a research fellow at the Institute of Finance Research
under the Chinese Academy of Social Sciences.
"The crux of the problem is that you have to keep the value
stable or increasing," Yi said.
The country's ballooning foreign reserves, many economists say,
is a major reason behind the increased money supply. This is
because the central bank has to issue additional currency to mop up
excess US dollars in the market, resulting in excessive liquidity
in the banking system.
Further, the fluctuating foreign exchange rate also poses a huge
risk, economists say.
In a bid to minimize such risks, the central bank should
diversify its existing US dollar-dominated foreign reserves
structure, and increase its holdings of euros or other major
international currencies, said Li Yongsen, a finance professor at
Renmin University of China.
The central bank, he said, could also buy more state bonds
issued by other major economies and decrease holdings of US
Treasury bills.
"It's better to spread the risks, and not put all your eggs in
one basket," Li said.
Li also suggested that China could consider using the huge
foreign reserves to purchase some strategic resource reserves such
as oil.
But such a plan should be implemented with caution, both Li and
Yi warned, citing the huge risks involved due to changing resource
prices.
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In the short term, increasing imports is an effective way to
decelerate foreign reserves, economists said. This would also
reduce trade frictions with some countries that have a high trade
deficit with China.
Experts also said the country should further relax controls on
capital outflow, in order to create a better balance of
international payments.
In a bid to ease foreign reserves and broaden investment
channels, China introduced the Qualified Domestic Institutional
Investor (QDII) scheme, allowing qualified companies to invest
overseas.
By October 10, the foreign exchanges regulator had granted
quotas worth US$11.6 billion to QDIIs.
"This is the right approach for creating a two-way capital
corridor," said Yi. "We used to put too much emphasis on attracting
foreign investment and feared capital outflow."
China is also shifting from a long-held policy of stockpiling
foreign reserves in state coffers, and instead encouraging
households and businesses to hold more foreign currency.
Individuals, for example, are now allowed to buy up to US$20,000
in foreign exchange a year, up from US$8,000 previously.
The practice before was that some foreign exchange reserves were
invested in banks.
Central Huijin Investment Company, an investment arm of the
central bank, injected a total of US$45 billion in foreign exchange
reserves into China Construction Bank and Bank of China in
2003.
It poured another US$15 billion into the Industrial and
Commercial Bank of China in 2005.
(China Daily October 30, 2006)