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A powerful buffer

(China Daily)
Updated: 2008-10-16 17:04

Fast accumulation of foreign exchange reserves had once deeply worried the Chinese government as it continuously glutted the domestic market with excess liquidity in recent years.

Yet, as the world economy gets increasingly exposed to the worsening global financial crisis, it seems that Chinese policymakers should begin to appreciate the strong protection that a huge stock of foreign exchange reserves provides for the national economy.

China's foreign exchange reserves hit a new record of $1.91 trillion at the end of September, up 33 percent from the same period last year.

The growth of forex reserves is still remarkable. A total of $377.3 billion was added to the foreign exchange reserves in the first three quarters.

But its impact on the Chinese economy has turned much more desirable than it used to be.

Just a couple of months ago when Chinese authorities were busy fighting inflation and preventing economic overheating, the huge inflow of foreign exchange was widely seen as a problem.

Nevertheless, against the background of a looming global slowdown, the accumulation of forex reserves serves as a natural way to pump needed liquidity into the slowing domestic economy.

Latest statistics indicate that the broad measure of money supply, or M2, increased 15.3 percent year-on-year by the end of September, the lowest pace since May 2005. To maintain China's stable and fast economic growth, the authorities have to expand money supply in one way or another. Under such circumstances, accumulation of more forex reserves will easily amount to a welcome boost in money supply.

However, a massive forex reserves plays for the country a more important role. It provides an effective buffer not only for the export sector but also for the Chinese economy in the face of growing financial instability and risks of economic recession around the world. With abundant forex reserves, the policymakers will have enough room for maneuver to both cope with external shocks and carry out domestic reforms.

In this sense, the slowed capital flow to China does make a cause for concern. The country's forex reserves grew by only $21.4bn last month, far below the foreign exchange inflow generated by a record $29bn trade surplus in September.

It is necessary to keep a close eye on the shift in forex flows to forestall any destabilizing flight of foreign capital. But it is far too early to worry much about the ongoing deceleration in the growth of forex reserves.

After all, China needs to cut its external imbalances to facilitate a change of growth pattern at home and help reduce global imbalances in coming years.