January 17, 2006
China, a Trade Superstar, Accumulates Foreign Currency (and Anxiety)
By DAVID LAGUE
International Herald Tribune
BEIJING, Jan. 16 - While some analysts view China's surge in foreign currency reserves as further evidence of the country's growing economic power, there are also fears that the growing hoard exposes the country to risks that could undermine future growth.
Even the official media are beginning to question the wisdom of this policy after China's central bank announced on Sunday that currency reserves had increased almost $50 billion in the fourth quarter of 2005, to a record $819.9 billion.
In a commentary distributed on Monday, the authoritative New China News Agency said the sharp increase was not entirely favorable because it could intensify disputes over China's trade surplus and lead to unwanted growth in the money supply.
And James McCormack, a credit analyst with Fitch Ratings in Hong Kong, commented: "The reserves are more than adequate. Maybe it is becoming excessive."
Only Japan, with $847 billion at the end of October, has greater holdings.
But there are signs that the accumulation of foreign currency is beginning to slow. China's reserves rose by $25.7 billion last month, growing more modestly than they had in December 2004, when they climbed $36.1 billion. The flood of speculative investment that poured into China through 2003, 2004 and the first half of 2005 has abated in recent months as China held down its interest rates even as the Federal Reserve pushed American rates higher.
Lower Chinese interest rates, together with a growing consensus in the market that officials in Beijing will not allow their currency, the yuan, to appreciate as fast as the Bush administration and the European Union want, have made it less attractive to invest in China.
Currency reserves here usually rise faster in December than in any month, partly because foreign investment deals are often concluded before the end of the year and partly because the Chinese statisticians tend to make adjustments to many categories of data, including foreign reserves, each December.
Still, some analysts argue that the reserves, which Beijing accumulates to maintain the yuan's link to the dollar, could lead to more trade friction with Washington because the Chinese trade surplus with the United States appears likely to exceed $200 billion in 2005.
Some economists also worry that the central bank will find itself under pressure to contain inflation that arises from its purchases of foreign currency. Others say the government's policy of investing about 70 percent of reserves in dollar-denominated assets is selling China short.
For example, these investments include some $247 billion in United States Treasury debt. The critics argue that these relatively low-yielding investments amount to a huge transfer of wealth from a relatively poor country to a rich one. They say the money can be invested more profitably in China's growing economy.
Economists and others worry that the huge increase in China's foreign currency reserves is almost certain to antagonize the United States and other big trading partners.
Since 2002, China's foreign exchange holdings have tripled, a measure of the scale of efforts here to hold down the value of the yuan and increase the competitiveness of Chinese exports.
To keep the yuan's value steady, the central bank buys a big slice of the foreign currency flowing into China from exports, foreign investment and speculative capital.
The growing reserves, said Chew Ping, a credit analyst with Standard & Poor's in Singapore, "will definitely add to pressure, especially from lawmakers in the U.S., for further appreciation of the yuan."
In July, China responded, allowing the yuan to appreciate by 2.1 percent against the dollar. It also introduced a system in which the yuan was allowed to trade in a narrow band against a basket of other currencies.
But this failed to silence critics of its trading policies, with some members of Congress threatening a 27.5 percent tariff on Chinese imports unless the government allowed further appreciation in the yuan's value.
So far, analysts say, there appears to be little evidence that the accumulation of foreign currency will fuel inflation. Such inflation fears arise because the Chinese government prints local currency to pay for the foreign exchange it buys.
But then, to contain the threat of rapid inflation from the growth in the money supply, the government sells debt to soak up the yuan it issues.
This appears to be working, with economists generally satisfied that the growth in China's money supply is in line with the expansion of its economy.
"There is a question about how long you can do that," Mr. McCormack of Fitch said, "but it is not as if the money supply is growing too fast."
Some economists also dispute contentions that China is unwise to invest so heavily in dollar assets. They note that returns on investment in China are relatively modest compared with the potential earnings from the country's foreign reserves.
"If you look at what most other money going into China is earning," Mr. Chew of S.& P. said, "it is not that inefficient. If you don't invest in U.S. bonds, what do you invest in?"
Yet there are signs that the government is becoming uncomfortable with the level of China's foreign-exchange accumulation. It has recently relaxed some currency controls so that businesses and individuals can take more money abroad. And on Jan. 5, Beijing, without giving details, said it would abolish limits on the amount that domestic companies could invest offshore.
Keith Bradsher contributed reporting from Bangkok for this article.