No adverse impact on dollar assets

Since the Chinese Government announced the plan of setting up a forex investment agency, foreign media expressed concerns that the move would cause fluctuations of the international financial market and have a negative affect on the value of U.S. dollar-denominated assets, for fear that dollar assets would be sold off and shifted into higher-yielding investments.

"It is true that in China's foreign exchange reserve, U.S. dollar-denominated assets account for quite a large fortune," Premier Wen said. "China purchases assets denominated by U.S. dollars in the mutual benefits of both countries. The new foreign exchange investment company will not have any adverse impact on U.S. dollar-denominated assets," he emphasized.

Many of the mammoth reserves are in the form of U.S. treasury bonds, long considered by international investors as a stable asset with modest returns. But the exact amount owned by China is a mystery, said Eswar Prasad, the Nandlal P. Tolani Senior Professor of International Trade Policy in the Department of Applied Economics and Management at Cornell University. He was previously chief of the Financial Studies Division in the IMF's Research Department and, before that, head of the IMF's China Division.

The IMF and many economists estimate that two thirds to three quarters of the reserves are in U.S. dollar instruments. The reserves include treasury bonds and agency bonds, Prasad said, but, again, the exact amounts are not disclosed and it is difficult to track the investments that are sometimes made through intermediary agencies.

The real concern for the United States is what China decides to do with additional foreign capital coming into the new management agency. If the euro is seen as a better investment than the dollar, for example, the United States could be affected. American economists are also closely watching to see what China will do with the current U.S. treasury bonds it owns.

"If the Chinese decided to dump $200 billion treasury bonds tomorrow, that would rattle the markets and get people concerned. The Chinese know that, so they're not going to do that," Prasad said.

It's in the interests of everyone involved not to cause too many ripples in international monetary waters, he said. Treasury bonds are still a good investment for China, as it may want to retain a large currency reserve to soften any possible economic crisis it could face as the region develops.

Cheng Siwei, Vice Chairman of the NPC Standing Committee, also pointed out that China won't randomly touch the stockpile of U.S. treasury bonds it has purchased. If it's sold off, it must cause fluctuations in the market, which will do harm to China itself. But the new reserves should be diversified in terms of currency denomination.

Challenges ahead

The incoming, large-sized state investment agency will definitely bring challenges to China. Ba Shusong, Vice Director of the Financial Research Institute under the Development Research Center of State Council, told China Economic Weekly that the new company will encounter the following problems:

- The amount of the reserve

If the company manages about $200 billion as estimated by media, it will still be the largest company in China. Moreover, the amount keeps growing. Such a large scale will certainly call the attention of the whole global financial market. Experiences of Singaporean Temasek can be learned from, but so far, the Singaporean forex reserve hasn't reached such a scale. Managers will be very familiar with international capital market and world economy.

- The yield rate

It is estimated that the state investment company will buy forex reserves from the central bank via issuing yuan-denominated bonds. However, the cost of issuing bonds, taking the appreciation rate of renminbi into consideration, will account for about 10 percent. That is to say, the yield rate of the new company should be more than 10 percent. It's not a low requirement for a large-scale investment company to keep a 10 percent return rate. How to employ specialized talents, establish information disclosure, and create assessment mechanism to increase the return rate pose great challenges.