China forex reserves rose to US$ 818.9b in 2005
(Bloomberg.com)
Updated: 2006-01-16 09:17

China's foreign-exchange reserves rose to a record last year, almost matching Japan's as the world's largest, as a swelling trade surplus and money inflows betting on a currency revaluation boosted holdings.

Reserves rose to US$ 818.9 billion at the end of December from US$769 billion at the end of September and US$610 billion a year earlier, the People's Bank of China said on its Web site today. Japan's foreign-exchange reserves stood at $824 billion at the end of November.

China has been investing its reserves in U.S. government debt and held $247 billion in treasury bonds at the end of October, making the nation the largest investor after Japan. The government is looking for new ways to invest the money to seek higher returns, China's currency regulator said on Jan. 5.

``The bigger the reserves get, the more nervous China is likely to be about keeping them predominantly in dollars,'' said Julian Jessop, chief international economist at Capital Economics in London. ``China's probably not going to do a lot with its existing reserves, but what it might do is put a smaller portion of its new reserves into dollars.''

The nation's reserves of foreign currency, which economists estimate are between 70 percent and 80 percent in dollars, have almost tripled since the end of 2002, lifted by about $170 billion of foreign investment, a cumulative trade surplus of $160 billion and billions of dollars of capital inflows betting on a rising yuan. China revalued its currency by 2.1 percent against the dollar in July and is under pressure from the U.S., Europe and Japan to let the yuan appreciate more.

Diversifying Assets

The central bank bought dollars from commercial banks first to maintain the yuan's peg against the dollar. Since the July 21 revaluation, it's bought dollars to limit the currency's gains, which have been kept at a total of 0.5 percent.

China may invest more of its reserves in other currencies, putting pressure on the U.S. dollar, the European Commission said in a report to European governments that was obtained by Bloomberg News Wednesday.

``There has been indications that China could begin to diversify foreign-exchange reserves away from U.S. dollar assets, something that could put downward pressure on the U.S. dollar,'' the commission said in its report.

Yi Gang, vice governor of the People's Bank of China, told reporters on Dec. 19 that China's policy of diversifying its foreign exchange reserves has long been part of the central bank's strategy.

``We have been trying to diversify for a long time,'' he said in an interview that day.

Inflation Potential

Seeking to slow growth in foreign exchange reserves, the government has relaxed some currency controls. It now allows Chinese companies and individuals to take more money out of the country and on Jan 5. scrapped the limit on investment overseas by domestic companies.

Even so, China's reserves may rise by another 20 percent to $1 trillion by the end of this year, which would the first time for any nation's reserves to reach that level, according to Standard Chartered Bank economists Stephen Green and Tai Hui.

The central bank buys foreign exchange to keep the yuan stable. Those purchases create more yuan, driving money supply growth and making it harder for the bank to control credit expansion.

Growth in money supply has accelerated since March and reached the fastest pace in almost two years in November, which the central bank attributed to a policy of increasing liquidity to support domestic demand and cushion the economy from the effects of July's revaluation.

``The biggest challenge for the central bank is to control the potential inflation that comes along with the buildup in reserves,'' said James McCormack, head of Asia sovereign ratings at Fitch Ratings in Hong Kong, in an interview. ``They seem to have managed reasonably well so far.''