Forex reserves tests China wealth handling ability
(Xinhua)
Updated: 2006-01-16 20:25

China's huge foreign exchange reserves, which amounted to 818.9 billion U.S. dollars by the end of 2005, have become a major news item that arouses much interest at home and abroad.

Chinese banknotes on display in Beijing.[AFP]

The government's foreign currency regulator's recent remark, that it will "further optimize forex reserve assets and widen forex reserves investment scope this year," has sparked a downward trend for the U.S. dollar in the international foreign exchange market.

Zhou Xiaochuan, governor of the People's Bank of China, the central bank, has publicly denied rumors that China would sell off some of its U.S. Treasury bonds.

An industry insider, who asked not to be named, explained in an interview with Xinhua that people worldwide are not showing much interest in the U.S. dollar since the cycle of U.S. dollar interest rate hikes by the US Federal Reserve is almost at an end.

Besides, the United States' huge trade deficit is still there. So any speculation in this regard can cause market response, he noted.

He said that China's decision to optimize its forex reserves is simply an illustration of the business principle of "not putting all your eggs in one basket."

"China needs to diversify its holdings to ensure their more effective management because forex reserves are climbing very fast," he said.

However, he noted that this does not mean that China will sell off its U.S. dollar holdings.

Figures published by the United States showed that while the U.S. dollar holdings of Japan and other countries fall, China's holdings are rising, the industry insider said.

An independent "chain" exists between China and the United States as China has a huge trade surplus with the United States, which helped increase China's forex reserves.

On the other hand, China spends forex reserves buying U.S. Treasury bonds, which helps reduce the latter's trade deficit.

"So, if China decides to sell off its dollar assets, it will be beneficial neither to China nor to the United States," the insider said.

His view was that U.S. dollar still dominates the international currency system and is still the main currency used in international settlement.

Besides, he said, if one takes a long-term view, the U.S. economy is performing better than the economies of Japan and the European Union countries.

This means that holding U.S. dollar assets instead of other currencies can achieve much better returns, he said.

China's foreign exchange reserves, the second largest in the world only after Japan, have grown remarkably in recent years thanks to strong fund inflows and a burgeoning trade surplus.

"The pace of build-up of forex reserves will continue to be strong in 2006," the insider said. "It's only a matter of time before China overtakes Japan."

He urged the central government to diversify currency holdings and buy corporate bonds to expand investment channels.

As to whether China's forex reserves are too big, Yu Weibin, a Ph.D with the Financial Institute of the Chinese Academy of Social Sciences, stressed the important role of forex reserves in dealing with financial crises, natural disasters and accidents and in supporting people's confidence in their own currency.

China should not change its policies regarding the forex reserves, Yu said.

However, he urged the government to adjust the structure of forex reserves and increase the proportion of mid- and long-term foreign treasury bonds with higher returns, so as to achieve better returns.