China's premier acknowledges foreign-exchange problem

China Plans How to Put
Huge Reserves to Better Use

From Reuters
Wednesday, September 6, 2006

http://today.reuters.com/summit/summitarticle.aspx?type=summitNews&summi...

BEIJING -- Premier Wen Jiabao said on Tuesday that China's foreign exchange reserves hoard had grown too fast, bloating money supply, but that the country was taking measures to make better use of its forex stockpile.

In an interview with Reuters and a small group of foreign media, Wen listed a series of steps China had taken to make better use of the reserves, which totaled $954.5 billion at the end of July, in order to ward off financial risks.

"It is true that the rapid and continued increase in China's foreign exchange reserves has caused the excessive buildup of foreign exchange reserves in the central bank and the oversupply of basic currency," Wen said.

"In view of this, we have given due consideration to the appropriate use of foreign exchange."

Wen said measures included increasing the imports of products and technology for China's reforms, and relaxed restraints on the use of foreign exchange by Chinese businesses and citizens.

China, like many countries, does not publish a breakdown of its reserves. Economists assume that around 70 percent is held in dollars, a proportion that some would like to see shrink to guard against a slide in the U.S. currency.

Some of the money had also gone into financing China's financial reforms, Wen said, in a reference to $60 billion of capital pumped into three of the Big Four state banks.

Economists said this and other moves had been necessary in the absence of measures to tackle the root cause of the reserves build-up -- a fat trade surplus and robust inflows of direct investment and speculative capital betting on a stronger yuan.

Wen said the big stash of reserves was a symbol of China's economic strength but acknowledged that it was also making life difficult for the central bank.

In order to hold down the value of the yuan, China's central bank buys most of the dollars flowing into the country and adds them to its reserves stockpile. The yuan it prints to pay for the dollars swells the money supply.

The yuan has risen a further 2.18 percent since it was revalued by 2.1 percent against the dollar in July 2005 and untethered from a dollar peg to float within managed bands.

The yuan is now at its highest level since the revaluation, but economists say the currency would have to rise much further to help reduce China's balance-of-payments surplus.

Wen ruled out a dramatic shift, however, promising instead to let the currency keep gradually rising in value.

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