China's foreign exchange reserves, the world's largest, have increased more in the first half this year than the whole of 2006.

Such accelerated accumulation is both unexpected and undesirable. Policymakers need to respond more aggressively.

Latest statistics show that the country's foreign exchange reserves soared by US$266.3 billion in the first six months to reach US$1.33 trillion.

This 41.6-percent year-on-year rise is, to a large extent, driven by the robust growth of trade surplus and continuous inflow of foreign direct investment (FDI). The country's net export and FDI that it drew in the first half year have increased by 83 percent and 12 percent respectively to US$112.5 billion and US$31.9 billion.

The current pace of forex growth, if it continues, points to forex reserves of about US$1.6 trillion. Even though the Ministry of Finance will issue special treasure bonds to buy US$200 billion of forex reserves to fund the country's new state investment agency later this year, the expansion of forex reserves will still significantly add to the country's liquidity challenge.

To attack the problem at its root, authorities should curb excessive export growth, boost domestic consumption and at the same time tighten control over inflow of speculative foreign capital.

In recent months, the country has time and again slashed tax rebates for a wider range of exports that are either energy-consuming or resource-intensive. It is possible that when these constraints on exports kick in later this year, trade surplus growth will be slowed.

Yet, given the powerful rise of China as a global manufacturing base, the rebalancing efforts may be undermined by the structural forces at work. Continuous inflow of FDI and robust investment growth at home will further expand the manufacturing capacity and push up surplus from processing trade.

While waiting for signs that current cuts of tax rebates will tame the growth of trade surplus, policy-makers should be ready to further lift the bar for exports.

On domestic consumption, the urgent task is to tap deeper into the ballooning national coffer to improve public health and education so as to sustain the spending spree that has just begun.

(China Daily 07/14/2007 page4)

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