Opinion / China Watch
Pressure on China forex management
(FT)
Updated: 2006-11-28 09:30
China's management of its $1,000bn foreign exchange reserves is coming
under pressure from a combination of rising domestic interest rates and
the fall of the US dollar on currency markets.
The US dollar fell on Friday to a 19-month low against the euro, in part
because of comments by Wu Xiaoling, a deputy governor of the People's
Bank of China, about the dangers of holding excessive US-dollar reserves.
China announced earlier this year that it would try to diversify the
composition of its reserves and to invest some of the money in
higher-yielding instruments, such as US corporate bonds, ahead of US
Treasuries.
Ms Wu's comments did not amount to any change of policy, according to
economists, but their impact did underline the sensitivity of the markets
to the issue of China's reserve management.
"I don't see a shift in the underlying policy - the market tends to
overreact," said Qing Wang, an economist with the Bank of America in Hong
Kong.
Andy Rothman, China strategist for CLSA, the brokerage, said Beijing had
changed the composition of its reserves in recent years, not by selling
US dollars but by buying less when making fresh investments.
"While a few years ago, maybe $75-$80 of every new $100 in reserves would
go into dollar assets, now possibly only $65-$70 do," he said.
China's huge holdings of US dollars make it sensitive to any weakening of
the greenback, because the PBoC would be forced to record the losses on
its balance sheet holding the reserves.
But Beijing's policy of keeping the renminbi more or less stable against
the dollar means it will inevitably accumulate even higher reserves.
To keep its currency stable, the PBoC uses renminbi to buy the dollars
coming into the country generated by a growing trade surplus, which then
accumulate as foreign reserves.
The PBoC attempts to keep the money supply from growing too quickly by
taking most of the renminbi used to buy dollars out of the system by
issuing central bank bills to local financial institutions - a process
known as "sterilisation".
Sterilisation has been profitable in recent years for the PBoC because of
the spread between low Chinese rates and the returns offered by US
Treasuries.
The one-year central bank bill has an interest rate of about 2.8 per
cent, more than two percentage points lower than US Treasuries with a
similar maturity.
But the PBoC has been caught over the last month by a rise in short-term
rates in the inter-bank market, which reached 3.9 per cent last Friday,
up from 2.4 per cent in November.
The seven-day rate in the inter-bank market is the closest thing China
has to a genuine market rate.
Hong Liang, an economist with Goldman Sachs in Hong Kong, said the rise
had been caused by large banks asking for higher rates from borrowers
they believed were using the funds to invest in newly buoyant local
stocks.
With the PBoC committed to large-scale sterilisation operations, Mr Liang
said "the central bank bills will have to compete on yields with other
demand for funds in the economy".
The PBoC was forced to delay an auction of "sterilisation" bills last
week.
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