China Tries Different Measures
http://www.chinaknowledge.com/commentary-analysis/article.aspx?id=175
China Tries Different Measures to Divest its Official Foreign Reserves
17 Aug 07
On August 14, news of RMB600 billion bonds to be issued soon as the first batch of special treasury bonds, topped China’s media headlines.
Just recently in June, the Standing Committee of the National People’s Congress approved the Ministry of Finance’s issuance of RMB1.55 trillion special treasury bonds for the purchase of about $200-billion foreign reserves. The foreign exchange will be used as registered capital of the newly founded state investment company, which is expected to be formally established by the end of September. The other two batches will be issued at RMB600 billion and RMB350 billion, respectively.
A day before also, the State Administration of Foreign Exchange announced on its website that the foreign-exchange quota in the current account of Chinese companies has been abolished. As a result, domestic companies are no longer obliged to convert their current account’s forex holdings into RMB.
Under the old rule, companies could retain foreign currencies equivalent to 80 percent of their previous financial year’s current-account income or 50 percent of spending. The remainder would have to be exchanged into RMB.
These are the most recent moves that China has employed in attempts to divest its vast official foreign reserves.
For individuals then, beginning February 2007, China has raised its individual annual forex quotas to $50,000 from $20,000 per year. In May, the China Banking Regulatory Commission announced that commercial banks with qualified domestic institutional investors status can issue wealth management products, which in turn can be invested in overseas stock markets. More securities companies are expected to join that investor list.
However while holding the same foreign currency reserves is prudent for one foreign-trade dependent country, China does feel its reserves are “too much.”
China’s fast-growing foreign currency reserves mainly stems from its double surplus in both current and capital accounts. In the first six months of 2007, China’s exports reached $546.7 billion, 27.6 percent higher than the same period last year and 9.4 percent higher than imports.
As a result, China witnessed a widening trade surplus, which hit a new high of $112.5 billion, an 83-percent increase compared with the same period last year.
Meanwhile, as one of the most-favored foreign direct investment destinations, its investment inflows have been growing again since 2006 after a temporary dip in 2005. Compared with the same period last year, utilized investments increased 12.2 percent, hitting $31.9 billion in the first half of 2007. At the end of June 2007, China’s foreign reserves reached $1.33 trillion.
Since China’s RMB is not fully convertible, China’s central bank, the People’s Bank of China, is forced to convert the accumulated foreign currency reserves into RMB and inject them into the financial system. This exacerbates the already-present problem of excessive liquidity.
In fact, the government worries more about the pace of foreign currency reserves accumulation, than the absolute amount. After all, China’s foreign currency reserves were only $400 billion at the end of 2003, and $140 billion at the end of 1997.
This excessive liquidity has caused China’s monetary tools, such as the interest rate hike and bank reserve ratio, to increase in attempt to rein in the economy. In the first half of 2007, China’s GDP grew at 11.5 percent, 0.5 percentage point higher than same period last year. While it is still arguable whether 11.5 percent means the economy is overheating, soaring asset prices should be of more concern.
On top of a 130-percent gain in 2006, China’s domestic stock markets rose another 60 percent by late May 2007. With an average price to earnings (P/E) of 50-60, China’s 10 percent growth hardly justifies the valuation.
Since the end of May, China’s stock markets have showed an extremely volatile pattern. On June 4, the Shanghai Composite Index dipped 8.26 percent and was even close to 3400 points the next day, over 900 points less than its peak on May 29. Yet since then, the Shanghai Composite Index continuously hits new highs, with only a temporary dip in July.
On August 13, the Shanghai Composite Index closed at a new high, reaching 4820, 1.49 percent higher than Friday’s closing. The Shanghai new high was created after the announcement of July consumer price index reaching 5.6 percent, a record-high in 10 years.
As millions of ordinary people’s fates are closely tied to the stock market, Beijing has been struggling to keep this bubble in check. Divesting official foreign reserves could be a more effective cure.