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UPDATED: July 23, 2014 NO. 28 JULY 10, 2014
Forex Forever?
China should control the growth of its foreign reserve assets and improve their management
By Wang Jun

The country has realized the challenges posed to its economy by massive forex reserves and taken some measures to reduce risks. Bearing in mind the principle of ensuring safety, liquidity and appreciation of funds, China has improved its management of forex reserves. The office of SAFE Co-Financing was established in June 2012, which provides U.S. dollar-nominated commercial loans to support the overseas operations of Chinese companies.

According to a press release by SAFE, the office is responsible for making innovations in the utilization of forex reserves. The relevant operations are all conducted under market principles and conditions, and all arrangements conform to general industry practices with respect to market choice, aiming to promote fair competition in the market.

The SAFE said in the release that since the launch of the co-financing office, it has provided a solid foundation and stable financing environment for China's financial institutions and players in the foreign exchange market by means of regulating supply and demand of funds. The SAFE has thus promoted national economic and social development, expanded the scope and fields of investment of forex reserves, and further diversified operations and administration of the reserves. In addition, by prioritizing risk prevention, it has maintained and increased the value of China's forex reserves.

Better management

In an interview with Economic Information Daily, Sun Huayu, Vice Dean of the International Business School of Guangzhou-based Jinan University, suggested that the country should not set higher earnings requirements in the management of forex reserves, but should diversify investment channels such as bonds, equity and real assets, thus seizing the opportunity to obtain considerable returns.

Zhang Monan, an associate research fellow with the China Center for International Economic Exchanges, said forex reserves are strategic reserves, so the government should not only consider the short-term book profits or losses, but pay attention to its relationship with national strategies with an eye to the long term.

Zhao Qingming, chief macroeconomic researcher with the Beijing-based CFFEX Institute for Financial Derivatives, said that though funds outstanding for forex have grown at a slower speed since the start of this year, the amount is still rising each month, and the quarterly capital account deficits that once emerged in 2012 are a thing of the past. "The funds outstanding for forex are likely to continue growing, therefore the crucial point is to control this growth," he said.

Zhang said that to do this, the government must use market-oriented methods and allow more foreign currency to flow into the hands of individuals and private enterprises. This will require coordination of reforming the renminbi exchange rate formation mechanism and promoting the renminbi's internationalization. "The surge of China's forex reserves is a byproduct of the yuan not yet being an international currency. If the yuan has a greater say in the international monetary system, China will no longer need such huge forex reserves to offset risks," she said.

"At present, China's forex is wholly possessed by the government in reserves, which is completely different from the situation in Europe and the United States, where forex is held by individuals and companies," said Yuan. The complicated approval procedures for overseas investment and lack of investment experience and capability have restricted Chinese enterprises, both state-owned and private, from making overseas investment.

There is ample space for China to enable more access to forex for individuals and enterprises, said Huang. With further improvement of the renminbi exchange rate formation mechanism and the two-way fluctuation expectations of the renminbi exchange rate, enterprises and individuals will be more willing to own foreign currency.

To control the growth of forex reserves, Sun said China must accelerate the process of opening its capital account and encourage more private companies to invest in overseas markets. "The government should appropriately control capital inflow while enabling more outflows. Only by encouraging more private capital to invest abroad can it really place forex reserves in the hands of individuals and enterprises," she said.

Email us at: wangjun@bjreview.com

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