By Xin Zhiming (China Daily)
Updated: 2007-07-27 11:50

China's trade surplus jumped 83 percent to US$112.5 billion from January to June as its foreign exchange reserves mounted to US$1.3 trillion.

Such figures have aroused concerns not only from its trade partners, but those who are not sure whether policymakers can handle the increasing liquidity.

Almost all agree that excess liquidity is flooding the Chinese market, but there is no consensus how the conclusion has been drawn.

"It's very hard to estimate the excess liquidity," said Stephen Green, senior economist with Standard Chartered Bank. "The measure I like the best is M2/GDP ratio, which hit 160 percent (in China) three years ago," he told China Daily.

M2 is the broad measure of money supply, which includes all types of deposits and cash. It exceeded 3.7 trillion yuan by the end of June, according to the central bank.

By the end of last year, China's M2/GDP ratio rose to 165 percent, much higher than Japan's 143 percent and 53 percent in the United States.

Economists also use other indicators to assess the situation, such as the gap between bank deposits and lending and the ratio of liquid assets to overall banking assets, which all point to excess liquidity in China.

The excess liquidity has come, fundamentally, from two sources: domestically, from accumulation of deposits; internationally, from inflow of capital such as the foreign exchange reserves and speculative money, according to Li Yang, director of the Institute of Finance and Banking, the Chinese Academy of Social Sciences (CASS).

China's imbalance in its investment and consumption structure has led to prolonged weak demand, which has exacerbated the pile-up of deposits, said Zhuang Jian, senior economist with the Asian Development Bank (ADB) in China.

The country's economy has been dependent on investment and exports in the past decade, not domestic demand, although the government is trying hard to increase consumption.

By the end of April, bank deposits held by the Chinese people amounted to 17.37 trillion yuan, nearly double the level five years ago.

It's a consensus that the public has preferred to save rather than spend because it anticipates long-term spending pressure from the country's restructuring of its pension, health and education systems.

China needs to raise labor wages and increase provision of such public services as education and healthcare to enhance people's spending propensity, Zhuang told China Daily.

The social security network must also be improved, which will also get people more active in consumption, Zhuang said.

From a global perspective, Li from CASS said that the low savings rate of developed countries has led to the trade deficit of these countries and the surpluses in Asian economies. The US has kept the dollar weak and, as a result, international markets have been awash with dollars.

Japan has seen a large-scale capital outflow into other countries. In Europe, statistics show the capital outflow is also on the rise as euro gets strong. It has also contributed to the global liquidity boom, Li said. And most of the capital has flown into Asia, including China, Li added.

Regarding capital inflow, Li suggested the holders of China's foreign exchange should be diversified, allowing individuals and enterprises to hold more of the reserves.

Although the central bank can sterilize foreign capital through issuing bills, raising the banks' reserve requirement ratio or conducting currency swaps, they can ease the pressure only temporarily, Li said.

Reforming the foreign exchange reserve management regime and allowing individuals and enterprises to hold more foreign exchanges would reduce the pressure on policymakers as they would need to sterilize much less foreign currencies.

To thwart speculative money inflows, Xia Bin and Chen Daofu from the Development Research Center suggested that policymakers should allow more volatile yuan trading, making the currency's long-term trends unpredictable.

"Authorities should allow the yuan to rise in a mixed tempo, sometimes slowly and sometimes quickly, to completely break the possibility for the market to predict the yuan's appreciation," they said in the report.

China also needs to raise its interest rate, because hot money holders not only want to benefit from a revalued yuan, but profit from the rising prices of assets. "The rising asset prices are closely related to our low interest rate," the economists said.