Central bank gives firms and citizens more freedom to hold foreign currency, but bets are on the yuan Mr Yao, who works at a semi-official trade organisation in Beijing, used to ferret out black marketeers to swap his yuan for US dollars. His work requires him to go on frequent overseas business trips. He would always use up his exchange quota of US$2,000, and sometimes buy more quota from his colleagues. 'I was hunting for every possible means to obtain more US dollars,' he said. 'The greenback had been going strong.' In the past five years, Mr Yao and millions of other Chinese have been given more freedom to hold foreign currency, but the 31-year-old's appetite for US dollars has dwindled. From February 1, mainlanders will be able to exchange up to US$50,000 a year for foreign currency, under a rule issued by the State Administration of Foreign Exchange early this month. The administration said the change would better serve growing demands for foreign currency. 'I welcome the relaxation. Freedom of capital is a basic human right,' Mr Yao said. 'But it came around a little too late. The yuan is now much more attractive than the dollar. I can hardly find any reason to exchange dollars other than for overseas travel - at least for the time being.' Mr Yao's lukewarm sentiment towards the dollar offers a side note on an issue that is increasingly bothering the central bank. Thanks to the yawning trade surplus and a steady inflow of foreign direct investment, China's foreign reserves have been swelling. By the end of last year, the country had historically high reserves of US$1.066 trillion, the central bank officially confirmed this week. But this massive asset is also a massive liability, economists say. In order to hold down the yuan's value, the central bank buys most of the dollars generated by China's trade and capital account surpluses, issuing yuan in exchange. Apart from opening the country to criticism it is manipulating the exchange rate to gain unfair trade advantages, the purchases create an economy awash in liquidity, which risks fuelling imprudent bank lending and rampant fixed-asset investment. And since most of the reserves are invested in US dollars - mainly in low-yielding US Treasury securities - its resources are inefficiently allocated. 'The massive hoard is now a headache for the central bank,' said Zeng Gang , an economist with the Financial Research Institute at the Chinese Academy of Social Sciences. One way to stop reserves rising is to relax restrictions on capital outflows and allow citizens to hold foreign assets. When central bank vice-governor Wu Xiaoling initiated a policy of 'storing foreign reserves among individuals and companies rather than in the state', its aim was to 'melt down excess foreign reserves through the market by making it easier for companies and individuals to buy foreign exchange and invest abroad', according to state media. The new rule is the central bank's latest attempt to ease capital account controls and help slow the build-up of foreign reserves. Broad changes in currency policy were launched last April. They allowed unprecedented access to foreign money. Individuals were permitted to buy US$20,000 a year, up from US$8,000. Domestic banks were allowed to tap overseas bond markets and firms retain more foreign exchange from their income. Despite the cosy safety net, Beijing has been wary of permitting capital outflows since the 1997-98 Asian financial crisis, when a sudden exodus of 'hot' money brought economies across the region to their knees, according to Mr Zeng. 'But now China's official reserves far exceed what is required to ensure financial stability,' he said. In theory, a country needs enough foreign exchange to cover three months' imports or to settle its short-term foreign debt. The amount now equals 15 months of imports and could pay off short-term foreign debt six times over. 'The changes are mainly aimed at spurring foreign exchange outflow and hence ease pressure on the yuan to appreciate,' Mr Zeng said. Nevertheless, the impact will be muted because of belief the yuan, which has risen about 3 per cent since it was revalued and unhooked from a decade-old dollar peg in July 2005, is a sure bet to rise. 'Capital outflow will occur only if there are expectations of yuan depreciation, as people will seek to send money overseas. But in the short term, the latest measures will not have a significant effect given expectations of a yuan appreciation,' Mr Zeng said. The underdeveloped state of the domestic forex market helped explain why there was less incentive to hold foreign currency, said Zhao Xijun , an economist with Renmin University's Finance and Equities Research Institute. 'We're still in the slow process of building a two-way market for foreign exchange, which should provide individuals and companies with more diversified investment vehicles and a more mature mechanism to hedge new found currency risk,' he said. Nonetheless, the new rule is viewed as an important demonstration of intent by the authorities to widen the channels for capital outflow to bring the demand and supply of the yuan into better balance. 'It's part of the broader and gradual process of capital account liberalisation, although it will have little immediate impact on the value of the yuan or in slowing down the piling up of foreign reserves,' Mr Zeng said.