Dollars to Spare in China’s Trove

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March 6, 2007
Dollars to Spare in China’s Trove
By KEITH BRADSHER
HONG KONG, March 3 — In the insular world of China’s central bank they are known as the Three Xiaos, three women with similar names who oversee the greatest fortune ever assembled: China’s more than $1 trillion in foreign exchange reserves.

The Three Xiaos are exceptions in the male-dominated world of Chinese policy making. And after the sharp fall in Chinese stock markets shook financial markets around the world, the three women face enormous challenges, including a potential showdown over government policies, with the meeting beginning March 5 of the National People’s Congress, the Communist Party-controlled national legislature.

Public pressure is mounting on the central bank, the People’s Bank of China. In postings on Internet message boards in China and in conversations among educated urban Chinese, critics suggest that the central bank should earn higher profits from its vast hoard — for instance, by taking more risk and investing in stocks — and use some of it to help a nation where most workers still earn less than a tenth of the wages of the typical American.

Foreign exchange reserves have soared across much of the developing world, in countries as diverse as Brazil, Thailand and India, but particularly in China. The reason lies in powerful currency intervention, as these countries strive to keep their exports competitive in Western markets by curbing the appreciation of their currencies against the dollar.

They have bought vast amounts of dollars from their exporters, giving back local currency in exchange. And then they have struggled with what to do with these dollars.

Most central banks have invested their dollars in American securities, particularly Treasury bonds and notes, but sometimes mortgage-backed securities as well. In recent years, these giant purchases have helped hold down interest rates that American home buyers pay for mortgages and the federal government pays to finance its budget deficits.

If central banks move out of such securities, that could push American interest rates higher. But moving into stocks, which tend to earn higher returns over the long term, poses market risks, as central banks carefully noted recently as the markets fell.

Some of the comments on Chinese Internet boards have been unusually strident. They have criticized the government for helping American taxpayers and home owners by investing hundreds of billions of dollars in Treasury debt and other securities instead of spending the money at home.

“China has huge amounts of foreign reserves; why doesn’t the government put more of it into education?” one posting this winter said.

Doubling the investment return on China’s foreign currency reserves, to 8 percent from 4 percent, would generate enough money to triple the nation’s education budget, said Tao Dong, the chief Asia economist at Credit Suisse. “Enhancing returns on the foreign exchange,” he said, “is natural and expected by the Chinese people.”

Yet spending the United States dollars on education and other domestic programs is not a simple task. The central bank would have to sell some of those dollars to buy the Chinese currency, the yuan, to be able to spend it on schools.

But in buying so many yuan, the central bank would nudge up the currency’s exchange value. That would make Chinese exports more expensive — something the bank has tried to prevent.

On top of that, it has already had to borrow yuan — by issuing bonds — to buy the dollars from exporters, and the bank would struggle to repay debts if it then spent its reserves on social programs.

The Chinese government may be poised to respond to the criticism later this month after it formally sets up a new investment agency, several people close to the government’s planning said.

Having invested for decades in the same Treasury securities that most governments purchase, China is now preparing to begin investing public money in stocks, corporate bonds and even commodities like oil and possibly strategic metals.

“That management has to be extremely professional,” said Rajat M. Nag, managing director general of the Asian Development Bank, alluding to central bank fund managers of numerous countries. “And I don’t think it can be done by bureaucrats.”

Both South Korea, which is preparing to move in the same direction, and China are trying in part to emulate the highly secretive Government Investment Corporation in Singapore. But China faces greater difficulties than Singapore, which has a tradition of highly professional money management and a civil service that is largely free of corruption.

By contrast, President Hu Jintao has identified chronic corruption as the biggest challenge facing China, and government officials tend to have fairly narrow expertise in managing asset portfolios.

The central bank faces a particular challenge in managing the country’s reserves. People close to the State Administration of Foreign Exchange, which is controlled by the central bank and manages the reserves, estimated that it already holds about $100 billion worth of American mortgage-backed securities. That is a somewhat unusual investment choice for a country’s foreign exchange reserves, but it was selected in the hope of achieving better yields than on Treasuries.

None of these mortgage-backed securities are said to be tainted by the subprime securities that have fallen sharply in value, though some bankers worry that troubles in the subprime market could spread to more creditworthy mortgages as well.

The central bank is highly secretive about its holdings. But experts estimate that it has a further $600 billion or so worth of Treasuries that it lends actively to generate profit, as well as at least $200 billion in euro-denominated bonds and the rest in bonds denominated in Japanese yen and other currencies.

State-controlled media in China have reported that a new government investment corporation could be asked to oversee up to $200 billion more, which would amount to roughly 10 months’ trade surpluses this year. Lou Jiwei, the man who is currently vice minister of finance, will most likely head the investment corporation, but no decision has been reached on the relative influence that the central bank and its rival, the finance ministry, would exert over the new agency, people close to the discussions said.

A final decision could be announced as soon as the National People’s Congress meeting, although the result will almost certainly be worked out behind closed doors before being presented to the congress for approval.

Representatives from a long list of the largest American, European and Chinese banks have approached the central bank and the finance ministry in recent months, hoping to win lucrative contracts to help manage the investment corporation funds. The central bank already lets banks manage small chunks of its foreign reserves under contract.

The State Administration of Foreign Exchange has a troubled history. One director in the 1990s, Zhu Xiaohua, was sentenced to 15 years in prison on charges of corruption during subsequent postings as a top bank executive; his wife committed suicide, and he has been released on bail to seek medical treatment.

Mr. Zhu’s successor at the agency, Li Fuxiang, was abruptly hospitalized in 2000 and then died mysteriously when he fell from a seventh-floor hospital window.

The foreign exchange administration has become a quieter place since the Three Xiaos rose to power there, people close to the administration said.

The leader of the three is Wu Xiaoling, 60, who became the administrator in 2000 upon the death of Mr. Li. She has since moved up to become the most senior deputy governor of the central bank, and remains particularly active on issues involving the country’s foreign exchange reserves.

The current administrator, and also a deputy governor of the central bank, is Hu Xiaolian, who turns 49 this year and is a rising star in Chinese financial policy making. The last of the three is Zhang Xiaohui, director general of monetary policy at the central bank.

The State Administration of Foreign Exchange declined to allow interviews. By coincidence, the governor of the central bank is a man who also has Xiao (pronounced SHEEOW) in his name: Zhou Xiaochuan, whom Ms. Wu is a possible candidate to succeed.

The Three Xiaos have very similar backgrounds. All have spent their entire careers working their way up through a succession of postings at the central bank, people who know them said. Ms. Wu and Ms. Hu even did their graduate work at the central bank’s own school, and are said to have been star students.

Their ascendancy in part reflects the departure of many men from the central bank over the last decade, to the point that women now dominate the senior ranks of the institution. Chinese Communist Party officials have insisted that central bank officials be paid no more than civil service wages, so that even fairly senior officials earn as little as $500 a month with minimal benefits.

By contrast, the China Securities Regulatory Commission, the China Banking Regulatory Commission and the big state-owned banks are all permitted to pay rates that are competitive with those in the private sector, with salary and benefits totaling at least $1,000 a month and sometimes $3,000. This has allowed them to lure managers from the central bank, as well as Chinese returning from overseas with doctorates in economics.

Unlike many Chinese government agencies, the central bank no longer owns hotels, restaurants or other businesses, having been forced by the government to divest themselves of them in the late 1990s to prevent conflicts of interest. It is common for officials at other agencies to hold second jobs at companies controlled by their agencies, and to have company cars and plush housing as a result.

The State Administration of Foreign Exchange has now been given permission to pay wages closer to market levels, but the rest of the central bank complex still struggles to hire China’s best and brightest, said Victor Shih, a Chinese banking specialist at Northwestern University.

“The pay issue,” he said, “is huge.”