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China's ever-expanding forex reserves

(AFP)
Updated: 2006-11-07 10:24

China's foreign exchange reserves have officially hit a record-shattering one trillion dollars, and they could top two trillion dollars sooner rather than later.

Even if Chinese officials have vowed to slow the growth in this huge stash of cash, they are up against vast and inexorable economic forces and, just as important, a national policy of keeping the currency stable.

"The rapid increase of foreign reserves results from long-term imbalances in the economy," said Zhang Taowei, a finance professor at Beijing's Tsinghua University. "They will probably continue to rise, even if at a slower rate."

China's reserves overtook Japan's to become the world's largest in February, and stood at 987.9 billion dollars at the end of September, according to previous government data.

Monday evening, they officially topped one trillion dollars, following a brief announcement on state television, citing the State Administration of Foreign Exchange.

In fact, they could very well double to hit two trillion dollars by late 2010, the People's Daily reported recently in its overseas edition.

It might take the Asian giant only until the second quarter of 2008 to hit 1.5 trillion dollars, the Communist Party mouthpiece said, quoting Zhong Wei, a professor at Beijing Normal University.

The inflow of foreign direct investment and a continuous stream of hot money aiming for short-term speculative gains have both helped reserves reach their current size, but booming exports are by far the most important factor.

The accumulated trade surplus in the first nine months rose to 110 billion dollars, already bigger than the 102 billion dollars recorded for all 12 months of 2005, according to customs data.

This is where the central bank's determination to keep the exchange rate stable comes in.

The inflow of money puts upward pressure on the Chinese currency, and the central bank has to counteract this by buying up foreign currency, adding to the already bulging reserves.

Economists warn that this trend must be stopped, or at least decelerated, because of the burden posed by managing super-large forex reserves.

"China has to slow its foreign exchange reserve accumulation because excess reserves are creating many problems," said Ding Zhijie, a professor with the University of International Business and Economics in Beijing.

One problem is that China can do nothing to curb the reserves without moving the markets, and hurting itself in the process.

For instance, if it were to shift just part of its reserve from US-dollar assets to assets in other currencies, such as the euro, the US currency would immediately plunge, and China's residual US-dollar assets would lose value.

Sun Lijian, an economist at Shanghai's Fudan University, agreed that steps will be taken to restrict growth in reserves, with a focus on reducing China's trade surplus.

"China needs to increase import as much as possible, and should especially buy more high-tech products from other countries. We can also buy technology from foreign countries."

A change in the overall trade patterns is the long-term solution to the growth in reserves.

A shorter-term fix would be to reduce the reserves at the margins, by using a few billion dollars here and a few billion there for specific purposes.

"Ever more senior leaders suggest that the forex reserves could be more usefully deployed," said Stephen Green, a senior economist with Standard Chartered in Shanghai.

"There's a strong possibility if not a likelihood that ... something like 10, 20 billion could be taken off and set aside for a strategic oil reserves or investment vehicles."

China has done so in the past, previously earmarking 60 billion dollars for recapitalizing its three largest banks, but central bank officials do not seem too enthusiastic about giving money away for free.

"Foreign exchange reserves are an item on the central bank's balance sheet," central bank vice governor Wu Xiaoling said last month.

"Whoever wants to use our reserves will have to use yuan to buy them from the central bank because we spent money buying them," she said.



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