How to look at and what to do with China's US$1 trillion Forex Reserve?

China has become the nation with the most foreign exchange (Forex) reserve globally with its reserve having for the first time topped the 1 trillion US dollar barrier by the late 2006, according to statistics released by the People's Bank of China. How the huge Forex reserve has accumulated, and what are its pros and cons or advantages or disadvantages, and how to use and manage the Forex reserve well? Three prestigious banking experts have answered and enunciated these questions. They are Xia Bin, the president of the Institute of Financial Studies under the Development Research Center of the State Council, Li Yang, president of the Institute of Financial Studies affiliated to the Chinese Academy of Social Sciences, and Professor Lu Feng with the China Economics Research Center of elite Beijing University.

Double surpluses give rise to a huge Forex reserve

A. What are causes for the accumulation of China's 1 trillion US dollar Forex reserve?

Lu Feng: The direct cause for the 1 trillion US dollar Forex reserve is ascribed to the sustained, double surpluses in China's international revenue and expenditure. In other words, both Forex income under constant account and capital account (the government reserve excluded) has surpluses, exceeding their spending in the international revenue and expenditure. The growth rate in China's processing trade had been apparently higher than that of the non-processing trade in the two decades preceding the country's reform and opening-up. Processed trade is an attribute of economy, and the mode of its balancing has a trait of pooling and creating Forex reserves, whereas China's non-processing trade, unlike the processing trade, has basically been in deficit. So it is impossible to have accumulated surpluses under the constant account without a surplus in the country's processing trade.

From the angle of capital account, direct investment from foreign businesspeople, which had amounted to more than 620 billion US dollars by 2006, can possibly scale the 670 billion dollar mark this year, and constitutes the most vital factor to prop up a surplus under the capital account. What merits particular attention is the fact that there is linkage between the direct investment by foreign investors and the processing trade. The relevant statistics of 2003 show that approximately 80 percent of processing trade was undertaken or participated in by overseas firms, with those enterprises with exclusive foreign investment assuming the leading role.

Xia Bin: Forex reserve is owned essentially by the government and it is a kind of liquid assets or liquidities that is convertible internationally. When a nation has owned Forex reserves of a certain scale, the reserves will not produce a direct impact on its economic entity. So, from this sense, there is no special need to worry about hefty Forex reserves.

Li Yang: The guiding principle concerning the Forex reserve management globally is how to seek relatively high investment proceeds under the precondition of maintaining appropriate liquidity. At present, China's task in this regard is to channel the massive Forex reserve capital into the country's development strategy of globalization instead of "using it up". How to use Forex reserve well and effectively in a bid to effect a shift from the export of commodities to the production export and capital export -- this should be a principal issue of concern.

A mater of milestone significance

A. How to look at the massive Forex reserve and what are its advantages and disadvantages?

Li Yang: As long as profits derived from the Forex reserve exceed the costs of hedging Forex reserve, then it is rational to hold the reserve. The more vital task for Forex reserves is to uplift a nation's current policy credit and increase its national strength. And Renminbi (RMB) has to depend on Forex reserve as a prop since it is not a strong currency. At present, China has raked in good proceeds in its operation of Forex reserve assets.

Lu Feng: China's Forex reserve exceeding 1 trillion dollars constitutes a matter of milestone significance, which marks a new era of Chinese economy. Fundamentally, the perspective of China's economic growth is determined by whether or not the sustained labor productivity growth can be spurred by sustained changes or variation in production function.

Xia Bin: If Forex reserve increases continuously and sustainedly, it might bring to China a negative or unfavorable impact in four aspects: First, it is detrimental to China's independent currency policy. Second, it is unfavorable to the operation efficiency of the overall Chinese economy. One the one hand, with a massive Forex reserve, the corresponding deposits of the nationals are meant to "settle down" in the operation of national economy instead of involving itself in the operation. On the other hand, there are huge capital gaps in numerous spheres out of historical reasons. Third, if the US dollar is devaluated with a big margin, China's loss cannot overlooked, as the country has a prolonged reserve of dollars. Fourthly, China has to endure a great global pressure. The protracted "trade war", "exchange-rate war" and other punitive measures a few individual countries have to take are very unfavorable to the international economic environment that is essential for the nation's peaceful rise.

Forex reserve can be used in the direction for China's urgent need

A. How to use and manage the hefty Forex reserve at present?

Xia Bin: With respect to China, its Forex reserve can be focused onto the direction of its urgent needs and be used to cope with short-term, urgent issues in its economic operation in coordination with the implementation of the sustained, national development strategy, and likewise to be used to tackle in-depth problems that have cropped up in the 28-year reform and opening-up. To date, consensuses relatively attainable are, among others, to purchase oil and other rare natural resources from overseas, some of the corresponding firms through buying of their shares and core technologies from overseas to foster innovation at home; set up funds in Hong Kong, employ ace talents with higher salaries; gradually improve its trade mix and commodity quality, increase gold reserve at any ideal, opportune time, and assist or support competent enterprise to "go overseas" to make investment.

Li Yang: Consideration can be given to set up special stabilization funds as those in the United States, Britain, Japan and other major economic powers with Forex assets as their property. As a first step, due consideration should given temporarily to dividing the Forex reserve into the two leading categories of fluidities and investment. For the category of investment, the objective of insuring or increasing values should be set forth and, with a certain amount of experience accumulated, some global fund managing agencies can also be opted to partake in the management of the Forex reserve of this category.

By People's Daily Online