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Mark O'Neill

Economists urge Beijing to give more back to the people

China's announcement that it has the largest foreign exchange reserves in the world has intensified the fierce debate over how to make best use of the money and whether this record level is more of a curse than a blessing.

The slogan in the debate is zanghui yumin - money stored for the public. After more than 50 years of centralised control over foreign currency, how much should the government give back to the people,  firms and institutions?

The People's Bank of China said in March that  reserves had reached US$853.7 billion at the end of February, overtaking those of Japan to become the world's largest. In addition, individuals and firms  held US$161.6 billion in foreign exchange savings at the end of last year.

The debate is over what level of reserves is suitable, how it should be spent and in what instruments and currencies  it should be kept.

Until now, the central bank has followed global practice, investing the money in bonds and bank deposits, with more than 60 per cent in US dollars, 20 per cent in euros and 10 per cent in yen.

Its belief that the current level is too high was a major reason for the Qualified Domestic Institutional Investor scheme it announced last month, which will allow mainland institutions and residents to invest a certain amount of money in financial products abroad and  permit insurance firms to invest  some of their assets in overseas fixed-income and money-market products.

It was the first time that domestic households and firms have been granted official access to overseas securities markets.

The central bank also raised the amount its citizens can exchange for US dollars to US$20,000 annually, from US$5,000-US$8,000.

Yet for many economists, these measures do not go far enough.

The most detailed proposal comes from Xia Bin, director of the financial research institute at the State Council's Development Research Centre, who says the proper level of reserves should be  US$700 billion, including US$266 billion to cover payment of foreign debt, US$360 billion to cover six months of imports, and US$70 billion to cover emergency situations.

He argues that the excess amount has brought about an unwelcome increase in money supply, excessive property prices, pressure on the yuan, overdependence on the US dollar, which is a depreciating currency, and that it is provoking friction with China's major trading partners.

He has proposed that China securitise a portion of the reserves so that individuals and companies can buy them.

China should  use the surplus  to import key technology, equipment and raw materials, to support mainland companies in  buying raw materials businesses abroad and buy stakes in international banks. Part of  it could be used to recapitalise state banks, he  said.

'How to effectively ease the upward pressure is vital for the yuan exchange rate reforms and also vital in resolving the problem of runaway growth in foreign exchange reserves,' said Mr Xia, who estimates that about 22 per cent of the increase in reserves last year came from funds speculating on  yuan appreciation.

'The authorities should keep the yuan's crawling appreciation and appropriately widen its floating band,' he said.

The Academy of Macroeconomic Research, under the National Development and Reform Commission, said China should spend excess reserves on foreign oil and other strategic commodities.

Mei Xinyu, an economist at the Ministry of Commerce's think-tank, said the huge trade surplus and foreign exchange reserves contained tremendous risks and the government should spur consumption, widen the channels for capital outflow and  give firms  the freedom to hold foreign currency rather than sell it to banks.

Zhou Maoqing, an economist at the financial research institute at the China Academy of Social Sciences, said that, while experts had different views on how to use the reserves, they agreed that it was only a matter of time before the central bank would reduce the US dollar portion and replace it with euro assets.

One dissenting voice is Jonathan Anderson, chief economist for Asia at UBS, who said in a research report in January that China's reserves were not especially high, if measured against  gross domestic product, annual imports or broad money supply (M2).

'The People's Bank should continue to hold the bulk of China's foreign exchange assets. The bulk of the holdings are in US dollar and euro assets and should stay that way,'  he wrote.



Bursting coffers force forex debate