China's surge in forex reserves prompts calls for monetary reform
Strong capital inflows, buoyed by rising interest rates and a strengthening currency, prompt calls for Beijing to implement monetary reform
China's forex reserves saw the sharpest ever jump last year, up by US$508.4 billion to a record US$3.82 trillion, piling more pressure on an already strengthening yuan and underscoring the need for monetary reforms.
The strong capital inflow, buoyed by higher interest rates and a 2.9 per cent appreciation of the yuan against the US dollar last year, showed no sign of abating and the trend would continue in the first quarter of this year, said economists.
Some experts say they wouldn't be surprised if forex reserves exceeded US$4 trillion by the end of this year, while urging the People's Bank of China to review its monetary regime and encourage more capital outflows.
"Rising interest rates may lure more forex into China," said Joe Zhang, a former central banker and the founder of financial advisory firm Slow Bull Capital. "This boosts unwanted reserves, pushing up the currency even though it may not be undervalued at present."
Zhang, who has been advocating higher interest rates since last year, said China needs higher rates to cool its property bubble, reduce wasteful investments and minimise the extent to which ordinary savers end up subsidising business. But the central government has been dragging its feet in fully liberalising the credit market, he added.
Market forces, however, have been driving interest rates higher, with interbank interest rates soaring to as high as 9 per cent from an average 3 per cent in June and December. The US$508 billion forex increase last year compares with US$130 billion in 2012 and US$334 billion in 2011.
A big chunk of last year's addition to the reserves came from the trade surplus, at US$260 billion. That surplus was 12.8 per cent higher than in 2012 and saw the biggest spike since 2009, when the financial crisis dented global demand.
A Nomura research report said trade was distorted by exporters' common practice of over-invoicing shipments in order to funnel hot money into the country's financial system by circumventing capital controls.
Forex reserves were also boosted in large measure by foreign direct investments (FDI), which leapt 5.3 per cent to a record US$117.6 billion last year, the Ministry of Commerce announced yesterday. The ministry said it anticipated "steady growth" this year on the back of improved global appetite for investments.
"Hot money inflow pressures could still be strong at the moment," Bank of America-Merrill Lynch economist Lu Ting said. "China's rising rates, yuan appreciation with limited volatility since last year and market expectation of further yuan appreciation make yuan investments quite attractive."
BBVA estimates the yuan will appreciate by 2 to 3 per cent this year against the greenback. Yesterday the yuan touched 6.0557 to the US dollar, inching closer to the psychologically important level of 6, according to China Foreign Exchange Trade System prices in Shanghai.
ANZ chief economist Liu Ligang said Beijing should deal with the issue of forex reserves by setting up a more flexible exchange system.
He said the central bank should encourage two-way capital flows by allowing private firms and residents to invest abroad, which he added could be done by lifting the annual cap of US$250,000 for mainland residents doing so.