Analysis: “Forex reserve not necessarily a good thing”, China finally aware
Xinhua Economic News Service
April 27, 2006 Thursday 8:00 AM EST
BEIJING, April 27 (CEIS) – Under pressures of rapid base money supply growth and fast appreciation of the home currency, it is now recognized by more and more people in China that foreign exchange reserve is not necessarily a good thing, and indeed the authorities are taking measures one after another to tackle this problem.
China has risen to the nation with the world’s largest amount of foreign exchange reserve starting from February this year, when the foreign exchange reserve hit 853.6 billion US dollars. By the end of March, the foreign exchange reserve increased further to 875.1 billion US dollars, an increase of 56.2 billion dollars over the figure by the end of 2005.
Since 1978 when China initiated reform and opened itself to the outside world, China’s foreign exchange reserve has largely undergone four growth stages. The first stage is from 1978 to 1993 when the scale of the country’s foreign exchange reserve was very small. The figure was only 1.6 billion US dollars in 1978. Thanks to the efforts to expand export and control import, it increased gradually, to 8.9 billion US dollars by 1983. The second stage is from 1994 to 1997 when fast growth was seen. In 1994, China reformed its foreign exchange management system, after which the two-tiered exchange rates were merged, the foreign exchange retaining mechanism was abolished, a foreign exchange surrender system was adopted and the interbank foreign exchange market was established. By the end of 1997, China’s foreign exchange reserve had hit 139.89 billion US dollars, up 5.6-fold from the 21.199 billion US dollars at the end of 1993. Accordingly, a stage of ample foreign exchange reserve came. The third stage is from 1998 to 2000 when the foreign exchange reserve increased slowly. Due to the Asian financial crisis, China’s foreign exchange reserve grew at a remarkably lower pace, with yearly increase of 5.097 billion, 9.715 billion and 10.899 billion US dollars only in 1998, 1999 and 2000. Even so, China’s foreign exchange reserve reached 165.574 billion US dollars by the end of 2000, ranking high in the world. The fourth stage starts from 2001, when the foreign exchange reserve increased sharply and the growth rate was amazing. From 2001 to 2005, China’s annual increase of foreign exchange reserve hit 46.591 billion, 74.242 billion, 116.844 billion, 206.681 billion and 209 billion US dollars respectively.
Such strong growth of foreign exchange reserve should have been attributed to some theoretical misunderstandings. Since late 1990s, it has been widely held that foreign exchange reserve growth reflects the growth of a nation’s economic power. For this, some local governments took foreign exchange earnings from export as one of the main goals in their economic work.
As a matter of fact, foreign exchange reserve scale may not necessarily reflect the economic strength of a nation. The foreign exchange reserve of credit nature originates from the surplus of payments under current account. It mainly reflects the export capacity of primary goods of Chinese enterprises in international competition. As to the foreign exchange reserve originated from the surplus under capital account, it is of debt nature and surely unable to represent economic strength.
Under the concept that foreign exchange reserve equals economic strength and the more foreign exchange reserve is the better, it is thus held that foreign exchange reserve should not be used unless utilization is crucial. As a result, China’s foreign exchange reserve was “reserved” but actually “useless” or not used. What the concept is reflected in foreign exchange reserve management are the ignorance of foreign exchange reserve’s economic benefits, social benefits and risk management, the ignorance of its operating efficiency, and the ignorance of its currency mix and asset structure. As a consequence, the foreign exchange reserve management lacks flexibility.
Excessive foreign exchange reserve has brought some hidden troubles to China’s economic development. The central bank has to use large quantities of bills or other means to offset by buying foreign exchange and supplying home currency. This in turn restrains the space of monetary policy operations and to some extent affects the independence of the central bank’s monetary policy operations. A report released by the Macro Economy Research Institute of the National Development and Reform Commission at the beginning of this year shows that some 80 percent of China’s foreign exchange reserve is US dollar assets, for which there are risks of contraction with the devaluation of the US dollar. Some experts and scholars also hold that the future yield of US bonds is not clear and excessive US dollar assets may cause great risks.
The authorities have recently noticed the negative influences of excessive foreign exchange reserve and are taking measures to ease them. Spokesman of China’s National Bureau of Statistics Zheng Jingping said recently that China had taken some measures to limit the export of high consumption, high pollution and resource-based products, and encourage the import of some equipments and high-tech products. Of course, this needs the cooperation of foreign governments and trading partners.
On April 13, the People’s Bank of China, the central bank, announced adjustment of its foreign exchange management policy, and accordingly, the State Administration of Foreign Exchange (SAFE) issued a circular, making specific arrangements with regard to the three newly adjusted foreign exchange management policies under current account, i.e. “abolishing examination and approval in advance for opening foreign exchange accounts under current account and raising the upper limit for foreign exchange account under current account”, “simplifying the certificates for exchange sale and payment in service trade and downgrading the examination and ratification power”, and “deregulating the policy for domestic resident individuals to purchase foreign exchange and implementing annual aggregate quota management”.
The reform measures are aimed to facilitate foreign exchange use by domestic enterprises and individuals so that foreign exchange is “stored among the people”, as remarked by vice governor of the central bank Wu Xiaoling.
Meanwhile, under the new measures, some qualified domestic institutional investors (QDIIs) will be encouraged and selected to invest abroad.
Earlier, a subject team of the Macro Economy Research Institute of the National Development and Reform Commission even suggests that consideration may be made to convert some newly added reserves into state strategic material reserve such as oil. The suggestion, though not necessarily adopted by the authorities, represents a new trend worth attention.
In order to avoid the contraction of assets caused by depreciation of the US dollar, the proportion of US bonds in China’s foreign exchange reserve has begun to decline slowly. Data released by the US Treasury Department recently show that by the end of February this year, China held 265.2 billion US dollars of US national bonds. Data released by China’s State Administration of Foreign Exchange earlier also show that China only added 3.1 billion US dollars of US national bonds in February, and the total amount of US national bonds held took up only 31.07 percent of China’s total foreign exchange reserve. Compared with the end of last year, the proportion had dropped by 0.23 percentage point.
Backgrounder:
1. Main contents of the adjustment of the foreign exchange management policy announced by the central bank on April 13.
-- For an enterprise to open, alter or cancel its foreign exchange account under current account, the practice of examination and approval in advance is adjusted to direct handling by banks in accordance with the requirements on foreign exchange management and conventional business practice, as well as recording at the foreign exchange administration. The upper limit for an enterprise’s foreign exchange account under current account is raised. Enterprises necessary to make external payments under true transaction background are permitted to purchase foreign exchange in advance.
-- Simplifying the certificates for exchange sale and payment in service trade and downgrading the power of examination and ratification.
-- Further simplifying the procedures for domestic resident individuals to purchase foreign exchange, raising the upper limit of exchange purchase and implementing annual aggregate quota management. Within the quota, an individual may handle exchange purchase at the bank and also report the purpose by presenting his true ID card. For personal exchange purchase in excess of the quota, the bank may supply exchange according to the actual need after examining necessary certificates.
-- Expanding banks’ foreign exchange asset management business done on agency, and permitting qualified banks to pool RMB funds from domestic institutions and individuals for purchase of foreign exchange used for investment in overseas products with fixed yields within a given quota.
-- Permitting qualified fund management companies and other securities operation organizations to pool own foreign exchange of domestic institutions and individuals for investment in securities portfolios including shares abroad within a given quota.
-- Expanding the overseas securities investment business of insurance organizations, and permitting qualified insurers to purchase foreign exchange for investment in products with fixed returns and money market tools abroad. The amount of exchange purchase is subject to control at a certain proportion to the gross assets of the insurer.
2. Main contents of the Circular issued by the State Administration of Foreign Exchange on April 13, which is to take effect on May 1 and makes specific arrangements with regard to the three newly adjusted foreign exchange management policies under current account, i.e. “abolishing examination and approval in advance for opening foreign exchange accounts under current account and raising the upper limit for foreign exchange account under current account”, “simplifying the certificates for exchange sale and payment in service trade and downgrading the examination and ratification power”, and “deregulating the policy for domestic resident individuals to purchase foreign exchange and implementing annual aggregate quota management”.
The first adjustment: abolishing examination and approval in advance for opening foreign exchange accounts under current account and raising the upper limit for foreign exchange account under current account.
The foreign exchange administration will no longer examine and approve in advance such matters as opening, altering and canceling foreign exchange accounts under current account by domestic organizations. If any domestic institution has already opened a foreign exchange account under current account and needs to open a new foreign exchange account under current account, it may directly handle the account opening procedures at a designated foreign exchange bank by presenting the letter of application for account opening, the business license (or the registration certificate for a social group) and the code of the organization. If it has not opened any foreign exchange account earlier, it shall first of all register the basic information of the organization at the foreign exchange administration by presenting the business license (or the registration certificate for a social group) and the code of the organization.
The upper limit for foreign exchange allowed to be retained at the foreign exchange account under current account of a domestic institution is raised, which is set according to the sum of 80 percent of the foreign exchange income under current account in the preceding year and 50 percent of the foreign exchange expenditure under current account. For a domestic institution without foreign exchange payments under current account in the preceding year but needing to open an account, the initial upper limit for the foreign exchange account under current account is readjusted to no more than the equivalent of 0.5 million US dollars.
If the domestic institution has true trade background and also needs to make external payment, it may handle exchange purchase in advance at the bank where the account is opened by presenting the valid certificates and commercial documents as stipulated by the Rules on Foreign Exchange Purchase, Sale and Payment and other related foreign exchange management laws and regulations, and also should deposit it into its foreign exchange account under current account.
The second adjustment: simplifying the certificates for exchange sale and payment in service trade and downgrading the examination and ratification power
Where it is necessary to make a payment under service trade account of the equivalent of 50,000 US dollars or less to an overseas institution or the equivalent of 5,000 US dollars or less to an overseas individual, the domestic institution or individual may handle the exchange purchase and payment procedures by presenting the contract (agreement) or invoice (notice of payment); if the amount exceeds the aforesaid limit, the original stipulations shall be followed. If any domestic institution or individual makes external payment under service trade account through the Internet and other E- commerce methods, the foreign exchange purchase and payment procedures may be handled by presenting the related contract ( agreement) and notice of payment downloaded from the Internet and also affixed with its seal or his signature.
For exchange sale and payment under service trade account for which the laws and regulations do not stipulate the certificates for examination, it shall be examined by the bank if the payment is to the equivalent of 100,000 US dollars or less, and by the local foreign exchange administration if the amount is to the equivalent of more than 100,000 US dollars.
For international marine shipping enterprises (including international vessel shipping, carrying with vessel, shipping agency and freight agency enterprises) that need to pay the freight and related fees under international marine shipping account, they may purchase exchange directly at the bank; in line with the business need, the goods owner may directly pay the freight and related fees under international marine shipping account to the overseas shipping enterprise.
The third adjustment: deregulating the policy for domestic resident individuals to purchase foreign exchange and implementing annual aggregate quota management.
Annual aggregate quota management is adopted for exchange purchase by domestic resident individuals, with the annual aggregate amount being the equivalent of 20,000 US dollars for every person. If a domestic resident individual purchases exchange within the annual aggregate quota, he may handle the purchase at the bank by presenting his true ID card and declaring the purpose. If the amount of purchase exceeds the annual aggregate quota, the purchase shall be handled after the bank examines the true need certificate as stipulated by the foreign exchange management regulations.
The exchange purchased by a domestic resident individual within the annual aggregate may be deposited in the domestic foreign exchange account of the person or be used for expenditure under current account. If the exchange is remitted out of the territory, or cashed in foreign currency or brought out of the territory, the original foreign exchange management stipulations shall be followed.
If a domestic resident individual purchases exchange within the annual aggregate quota, he may handle the purchase by himself or have it handled by his linear relative on agency. If it is handled by a linear relative, the ID certificates of the resident individual and the proxy and the certificate for their kinship, as well as the letter of proxy, shall be presented.
Also, the foreign exchange administration no longer implements write-off management on exchange purchase by domestic resident individuals. |
