China’s excess FX reserve isn’t “optimal,” says PBC’s Zhou


Published on:

China’s unreasonably high levels of excess currency reserves aren’t optimal for resource allocation, but finding a better use for those reserves will take time, says the governor of the People’s Bank of China, Zhou Xiaocuan, in an exclusive interview with Euromoney.

“There can be a better alternative that produces greater social welfare and more healthy economic growth,” says Zhou. But “achieving a better alternative, of course, would take some time and this is especially true for a large economy.” China’s FX reserves are forecast to continue to grow. Its financial account surplus is getting bigger and was $221 billion in 2010, including $185 billion of net foreign direct investment inflows. Moreover, its current account surplus was $270 billion and its financial account surplus is around $200 billion. Standard Chartered expects China’s FX reserves will grow by $470 billion this year to $3.3 trillion – about 48% of China’s GDP and 5.1% of global GDP, and to be near $5 trillion by the end of 2014. That’s a problem at a time when there are few stable options for China to invest its surpluses. Investment in US and European government debt has been inevitable, as the reserves grew too fast to do much else. That makes reversing these investments amid the turmoil in sovereign debt markets a difficult proposition. “Technically, managing reserves of a certain size is not particularly difficult. The difficulty comes from excessive external volatility and uncertainty. Optimizing the allocation of FX reserves requires China to promptly implement the 12th Five-Year Plan, accelerate the transformation of the economic structure and economic growth model, and achieve a better macroeconomic balance.” China can continue to diversify away from the US dollar over time, but there is no point spending a lot time or energy worrying about it, says Stephen Green, who heads up Standard Chartered’s Greater China research team. There are many more important things China can do to move down the path to a new economic model and sustainable growth. According to Green, the strong dollar is over; it is now time for a stronger renminbi policy. He argues that Washington’s strong dollar policy has been little more than a commitment not to intervene directly in the markets in recent years. A de facto weak dollar policy is emerging as the US seeks to boost external demand for its manufactured goods, he says. China should not blame the US too much for this. Since the early 2000s, China has kept the Chinese yuan weak in order to protect its exporters and generate jobs. But as domestic demand develops and the country’s strategic needs evolve, China should be happier about moving towards a stronger renminbi policy. A stronger currency would push the country’s exporters up the value chain, push more resources into domestic services, make securing overseas assets cheaper and help global demand, says Green. The consequence of keeping CNY weak for longer will be more inflation and more US Treasury purchases. Once CNY reaches a level that is close to balancing the current and capital account, it will become much easier to get interest rates higher. Assuming no big external shock, now is the time for China to move fast on the CNY. “One of the costs of excessive FX reserves is the difficulty it brings to inflation control. This is why PBC makes great efforts in sterilization operations to absorb the base money supplied through reserve build-up, ” Zhou tells Euromoney.