China reserve growth triggers market ripples
(Financial Times)
Updated: 2006-01-17 08:29

http://news.yahoo.com/s/ft/20060116/bs_ft/fto011620061448563529

News that China's foreign exchange reserves rose sharply in the final quarter of 2005 and are on course to overtake those of Japan as the largest in the world by the end of 2006, caused a predictable ripple of excitement in the currency market on Monday.

The knee-jerk reaction was that the continuing growth in Chinese reserves, which rose by a further $50bn to $819bn in the last quarter, would maintain pressure on the Chinese authorities to allow faster appreciation of the renminbi, thereby reducing the need to intervene in the currency market, building up yet more reserves in the process.

Since July's 2.1 per cent revaluation of the renminbi, the currency has only been allowed to rise by a further 0.54 per cent to Rmb8.066 to the dollar, in spite of moves of up to 0.3 per cent a day being theoretically permitted under the new foreign exchange regime.

However, the forwards market moved to price in a slower pace of appreciation, with the six-month contract on Monday forecasting a rate of Rmb7.88 by July, a gain of 2.3 per cent, rather than the Rmb7.868 quoted on Friday.

Derek Halpenny, senior currency economist at Bank of Tokyo-Mitsubishi UFJ, rationalised this move by arguing that the reserves data was essentially in line with market expectations, while money supply data, also released on Sunday, undershot expectations.

Although M2 money supply rose 17.6 per cent in the year to December, this was below the 18.3 per cent rate reported a month earlier, potentially reducing pipeline inflationary pressures and the need for the People's Bank to allow faster currency appreciation to help nip pressures in the bud.

"We believe the key determinant of any shift in [foreign exchange] policy will come from evidence of building inflationary pressures," said Mr Halpenny, who noted that such pressures are still lacking. Inflation has fallen from 5.3 per cent in August 2004 to only 1.3 per cent, with the Chinese authorities having raised the prospect of "slight deflation" in the second half of 2006.

Julian Jessop, economist at Capital Economics, argued that reserve growth is actually slowing, with the increase in each of the past four months lower than that in the same month a year earlier as hot money inflows have "slowed sharply".

But Stephen Jen, global head of currency research at Morgan Stanley, swam against the tide, claiming China's reserves are now so large that this could be the "year of the renminbi".