Forex Forever?

By+Wang+Jun

Chinas foreign exchange （forex） reserves surpassed $2 trillion in April 2009， and a mere five years later， the number doubled by the end of June. This figure accounts for a staggering one third of all forex reserves worldwide.

The colossal size of Chinas forex reserves has elicited commentary from the countrys top leadership. During his visit to Africa in May， Premier Li Keqiang said that the large pool of forex reserves has become quite a serious burden for China since the central bank has to issue home currency to purchase forex， which can stoke inflation.

Analysts think the government should encourage individuals and enterprises to hold onto more foreign currency and invest in foreign markets.

Yuan Gangming， a researcher with the Institute of Economics at the Chinese Academy of Social Sciences， said continual growth in forex reserves is the result of export growth and the introduction of foreign investment.

“China has a trade surplus， bringing in an increasing amount of forex. Moreover， China is continuing to adopt preferential policies to attract foreign investment. All these are favorable outcomes of the reform and opening-up policy，” said Yuan.

Maintaining sizeable forex reserves is of great significance for the country， said Huang Guobo， chief economist of the State Administration of Foreign Exchange （SAFE）， in an online interview on June 12. During the past decade， large foreign reserves have helped fend off the impact of the global financial crisis， support economic growth， increase employment and raise fiscal revenue and resident income， said Huang.

Tan Yaling， President of the China Forex Investment Research Institute， said maintaining large reserves can help prevent overly speedy appreciation of the renminbi and help safeguard against the prospect of a financial crisis.

“To a developing country， having enough in forex reserves is vitally important. The fact that we were able to withstand the Asian financial crisis in 1997 is because China had large forex reserves，” Tan elaborated. “Therefore we should not ignore that maintaining a certain level of forex reserves will help offset financial risks.”

Burden to bear

China does need foreign reserves up to a certain level， to conduct international transactions and deal with potential risks， but excessive foreign reserves represent an unendurable burden.

Huang said the rapid growth in forex reserves has intensified difficulties in macrocontrol， increased inflationary pressure， and restricted the flexibility of monetary policy. Whats more， it has created a larger exchange rate risk for the central bank and made the management of forex reserves more difficult.endprint

According to Huang， forex reserves now account for more than 80 percent of the central banks assets， leading to a mismatch between asset and liability， one which raises forex risks.

During the June 12 online interview， Guan Tao， Director of the Balance of Payments Department of the SAFE， said China had already made it clear that it will not pursue high forex reserves. The proportion of Chinas current account surplus against GDP dropped from a record high of 10.1 percent in 2007 to 2 percent in 2013， much lower than the internationally recognized standard.

The country has realized the challenges posed to its economy by massive forex reserves and taken some measures to reduce risks. Bearing in mind the principle of ensuring safety， liquidity and appreciation of funds， China has improved its management of forex reserves. The office of SAFE Co-Financing was established in June 2012， which provides U.S. dollar-nominated commercial loans to support the overseas operations of Chinese companies.

According to a press release by SAFE， the office is responsible for making innovations in the utilization of forex reserves. The relevant operations are all conducted under market principles and conditions， and all arrangements conform to general industry practices with respect to market choice， aiming to promote fair competition in the market.

The SAFE said in the release that since the launch of the co-financing office， it has provided a solid foundation and stable financing environment for Chinas financial institutions and players in the foreign exchange market by means of regulating supply and demand of funds. The SAFE has thus promoted national economic and social development， expanded the scope and fields of investment of forex reserves， and further diversified operations and administration of the reserves. In addition， by prioritizing risk prevention， it has maintained and increased the value of Chinas forex reserves.

Better management

In an interview with Economic Information Daily， Sun Huayu， Vice Dean of the International Business School of Guangzhou-based Jinan University， suggested that the country should not set higher earnings requirements in the management of forex reserves， but should diversify investment channels such as bonds， equity and real assets， thus seizing the opportunity to obtain considerable returns.

Zhang Monan， an associate research fellow with the China Center for International Economic Exchanges， said forex reserves are strategic reserves， so the government should not only consider the short-term book profits or losses， but pay attention to its relationship with national strategies with an eye to the long term.endprint

Zhao Qingming， chief macroeconomic researcher with the Beijing-based CFFEX Institute for Financial Derivatives， said that though funds outstanding for forex have grown at a slower speed since the start of this year， the amount is still rising each month， and the quarterly capital account deficits that once emerged in 2012 are a thing of the past. “The funds outstanding for forex are likely to continue growing， therefore the crucial point is to control this growth，” he said.

Zhang said that to do this， the government must use market-oriented methods and allow more foreign currency to flow into the hands of individuals and private enterprises. This will require coordination of reforming the renminbi exchange rate formation mechanism and promoting the renminbis internationalization.“The surge of Chinas forex reserves is a byproduct of the yuan not yet being an international currency. If the yuan has a greater say in the international monetary system， China will no longer need such huge forex reserves to offset risks，” she said.

“At present， Chinas forex is wholly possessed by the government in reserves， which is completely different from the situation in Europe and the United States， where forex is held by individuals and companies，” said Yuan. The complicated approval procedures for overseas investment and lack of investment experience and capability have restricted Chinese enterprises， both stateowned and private， from making overseas investment.

There is ample space for China to enable more access to forex for individuals and enterprises， said Huang. With further improvement of the renminbi exchange rate formation mechanism and the two-way fluctuation expectations of the renminbi exchange rate， enterprises and individuals will be more willing to own foreign currency.

To control the growth of forex reserves， Sun said China must accelerate the process of opening its capital account and encourage more private companies to invest in overseas markets. “The government should appropriately control capital inflow while enabling more outflows. Only by encouraging more private capital to invest abroad can it really place forex reserves in the hands of individuals and enterprises，” she said.endprint