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Wang Xiangwei

One of the most impressive achievements of the Chinese economy last year was the phenomenal growth in foreign exchange reserves, which passed the US$100 billion mark for the first time on November 12.

 The reserves have doubled in two years, ranking China second only to Japan in the world.

  Many foreign investors have shown curiosity in the spectacular growth in the reserves, which could shed some light on China's policies on foreign trade, balance of payments, inflow of foreign capital and the external value of the yuan.

  It is appropriate to ask if the hard currency reserves will grow as strongly this year, not to mention the underlying implications for policy-makers.

    To answer the question, one needs first to explain why the foreign exchange reserves have risen so rapidly in the past two years.

  The build-up came mainly from two sources: foreign direct investment and the trade surplus.

  Charles Li, of Natwest Markets, expects China to ring up US$40 billion in utilised foreign direct investment for 1996, making it the world's second-largest recipient for the third consecutive year, after the US.

   China, the world's 11th-largest trading nation, is expected to post a 1996 merchandise trade surplus that, while lower than 1995's record surplus of US$16.7 billion, will be much better than was expected at the beginning of 1996.

  Significant policy changes have also pumped up the reserves.

   In 1994, Beijing introduced a compulsory settlement policy that meant domestic firms were forced to sell their hard currency earnings to state banks, whereas in the past they could retain the rest after handing over the agreed annual quotas.

  Under the new regulations introduced earlier last year, China abolished the foreign exchange swap centres and required foreign-funded enterprises to trade hard currency at the larger and much more liquid inter-bank market.

  The strong inflow of foreign exchange, coupled with the country's tight money supplies, has meant an oversupply of US dollars, which has driven up the yuan's exchange rate against the greenback.

  As the sole yuan liquidity provider in the interbank market, the People's Bank of China has no choice but to mop up the excess supply of hard currency in order to stabilise the yuan's exchange rate.

  Mr Li believes that in the first 10 months of the year, the central bank purchased an average US$84 million a day in the interbank foreign exchange market, resulting in an increase of $25 billion in foreign exchange over the period.

  Looking ahead for this year and beyond, however, he believes that a rising current account deficit and an expected slowdown in foreign direct investment will translate into slower growth in foreign exchange reserves.

   On the shaky current account, Mr Li said that while the merchandise trade surplus has been strong, the services deficit soared sharply in 1995, which left China's current account surplus at $1.6 billion that year - much lower than most analysts had expected.

  Mr Li claims the biggest burden on the services account will be the investment balance, which includes outward profit repatriation by foreign investors.

  Official figures show that profit repatriation rose to $10 billion in 1995, from $400 million in 1994.

  Last year might have been the beginning of a new cycle of large-scale profit repatriation.

  Mr Li estimates that, assuming a 10-year pay-back period, one should not be surprised to see $14 billion a year in profit repatriation based upon the existing direct investment of more than $160 billion.

  What it probably means is that although China is expected to register a merchandise trade surplus, it is unlikely to be sufficient to offset the deficit on the services account, which will probably leave a current account deficit in the years ahead.

  On the capital account, China overwhelmingly relies on foreign direct investment for its long-term external funding these days instead of the foreign loans in the 1980s. Since 1993, the capital account surplus has rocketed, reaching $38.7 billion in 1995.

  All this means that in the future China will have to try to maintain a large merchandise surplus in order to minimise the overall current account deficit.

  Secondly, in order to finance the expected current account deficit and to meet its foreign debt obligations, which also stand at more than $100 billion, it will also have to rely on a capital account surplus.

  Thus, the ability to continue to attract foreign investment is crucial.

   The central bank, meanwhile, was expected to maintain its policy on the yuan's exchange rate, which would move within a narrow band of 8.3 to 8.4 yuan to the US dollar in 1997, according to Mr Li.



Foreign reserves growth makes an impression