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 was a 1.52 per cent drop year-on-year.
Reserves grew on average US$18.8 billion each 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 Science.
"The crux of the problem is that you have to keep the value stable or
increasing," Yi said.
The ballooning foreign reserves, many economist say, is a major reason behind
the loose money supply. This is because the central bank has to issue additional
money to mop up the excess US dollars in the market, resulting in excessive
liquidity in the banking system.
And the fluctuating foreign exchange rate also poses a huge risk, economists
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,"
The professor also suggested that the country might consider using the huge
foreign reserves to purchase some strategic resource reserves such as oil.
But such a plan should proceed with caution, both Li and Yi warned, citing
the huge risks involved due to changing resource prices.
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.
Economists 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 has
introduced a QDII (Qualified Domestic Institutional Investors) scheme, allowing
them to invest overseas.
By October 10, the foreign exchange 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 the previous US$8,000.
Previously, China invested some foreign exchange reserves 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.