China’s Forex

Dariuz KowalczykChina’s FOREX reserves have been escalating substantially over the past five years. In 2009, the figure exceeded $2 trillion and by the end of last month, that number nearly doubled! China’s FOREX makes up a a third of all FOREX reserves worldwide. According to Li Keqiang, this figure has become somewhat burdensome for China, forcing its Central Bank to issue home currency for the purchase of FOREX, which can increase inflation.

Given this situation, experts have advised officials to encourage business people to keep hold of foreign currency and put their monies into foreign markets. One possible explanation for such FOREX reserve escalation is the export increase and foreign investments that are coming to China. Since the region has a trade surplus, further FOREX arrives. And, given that China is becoming an increasingly attractive place for FDI, this further stokes the issue.

In a response to these and other related issues, officials widened the freedom of its banks to set foreign-currency deposit rates in Shanghai. With this, interest-rate controls would be facilitated countrywide. According to senior economist at Credit Agricole SA, Dariuz Kowalczyk, “this is a small step in deposit-rate liberalization because forex deposits are a tiny fraction of the total. However, the removal of Forex deposit caps does represent a step towards liberalization of interest rates and will increase hopes for raising the cap on yuan deposits in coming months. This in turn would lead to higher rates throughout the economy.”

In addition, the People’s Bank of China recently began a trial period on removing the ceiling on foreign currency deposit rates for small accounts at first. Later on, should this go well, it will be extended to other accounts, contingent on the current market conditions.

To a certain degree, China needs its FOREX reserves. But for global transactions and to cope with potential risks they are necessary. However, in excess, they result in an “unendurable burden.”