Yin said it is estimated that the $200 billion in forex purchased through special bonds is equivalent to the forex reserve growth in 2005. The special bonds will help the central bank hedge its functions, enable it to manage monetary policies more effectively, optimize the cooperation of fiscal policies and monetary policies, and improve macroeconomic control.

What's the use?

It seems simple to buy $200 billion in forex by issuing the special bonds. As a matter of fact, the decision is much more complicated than it looks.

Currently, the Chinese forex reserve is continuing to climb to record highs. China now holds the largest forex reserve in the world. By the end of 2006, the national forex reserve had grown to $1.07 trillion, 5.4 times more than what it was at the end of 2000. By the end of March 2007, the reserve scale amounted to $1.2 trillion.

According to the decision of the NPC Standing Committee, the capital earned from selling special bonds will be used as starting capital for the national forex investment company to be established later this year. According to the International Monetary Fund's standard, forex reserves bought through treasury bonds are no longer counted in the national forex reserve, and once the transaction has been completed, a sixth of China's forex reserve will be in the hands of market players.

Of course, the $200 billion won't pose a fundamental change to the skyrocketing forex reserve. Some investment banks estimate that new forex investment company will buy $5-15 billion in foreign currency monthly, while the major source of capital will still come from the selling of special bonds.

Jin said the forex investment company will invest in overseas industries and financial products, and yields from the investments are believed to be higher than the rate of special bond interest.

Issuance pace is key

Some analysts are concerned that the special bonds will pose a great threat to the market.

Liu Shangxi, Deputy Director of the Research Institute for Fiscal Science at the Ministry of Finance, believes the special bonds will have a positive impact on the nation's economic development, and that yields from the forex market will improve.

But the market isn't as optimistic as Liu says. "The bond market is in chaos and people are confused about what they should do," said Hu Hangyu, an analyst from CITIC Securities. According to Hu, the trading volume, especially for long-term bonds, is very small.

The market confusion is caused by interest rate hike expectations and the issuance of special bonds. "The problem is that we don't know what the government will do with the special bonds," Hu said.

The bond market reacted quickly to the special bond news. Some institutional investors said they wouldn't buy long-term bonds because they fear the bond market will eventually collapse. The bond market dropped continuously up to July 6, following the news of the special bonds.

Peng Xingyun, another researcher at the Institute of Finance and Banking of the CASS, said if the 1.55 trillion yuan in special bonds were to be sold all at once, the results would be cataclysmic. The effect would be tantamount to raising the reserve requirement ratio eight to nine times. Such a decision would require careful consideration, he added.

The special bonds are expected to greatly push the yields of long-term bonds to high levels. Peng believes the interest rate of 10-year treasury bonds will be pushed to as high as 5-6 percent.

Zhong Wei, financial professor at Beijing Normal University, said the issuance pace of the special bonds will decide whether it will challenge the excessive liquidity. He said the Ministry of Finance has little experience in handling such amounts of money, and it needs the close cooperation of the central bank. Issuing the special bonds poses great uncertainty to the domestic bond market, he said.

In terms of the stock market and banks, the impact of the special bonds seems less certain. Xia Bin, Director of the Financial Research Institute of Development and Research Center of the State Council, said the central bank only needs to use the special bonds to guide liquidity and no longer has to sell central bank notes. Xia believes special bonds won't cause the stock market to crash.

As for banks, Xia believes their profitability won't be affected. "The special bonds are just a substitute for the central bank notes," he said. "For most of the commercial banks, the special bonds provide them with a new choice of credit."