Central banks are facing challenges to manage growing foreign reserves due to unsteady global economic recoveries, geopolitics and oil price hikes.

In a speech published by China's State Administration of Foreign Exchange (SAFE) yesterday, deputy director of the administration Wei Benhua said drastic fluctuations in international financial markets in the wake of their latest cyclical changes have amplified the need for central banks to optimize currency and asset structures of their forex reserves, and readjust their investment management methods.

"With the scale of foreign exchange reserves growing, many countries, including China, are facing many new challenges in their foreign exchange reserve management," Wei said. Wei gave the speech at a meeting of central bankers late last month, SAFE said.

The world's total forex reserves amounted to US$3.02 trillion at the end of last year, almost tripling that of 10 years earlier, the official said.

The low interest rates in international markets, at years' low in many countries, pose a challenge to central banks as to how to improve yields on their forex reserves, Wei said.

The rapid increases in forex reserves are also challenging the conventionally dominant function of forex reserves as a way to safeguard a nation's macroeconomic security.

"With the scale of foreign exchange reserves growing to new records, foreign exchange reserve management faces a new problem, of whether they should be used as a flexible instrument to interfere in the foreign exchange market, maintain stability in the banking system and assist the implementation of monetary policy, or be invested for higher yields," Wei said.

There has been heated debate among Chinese economists as to whether keeping the nation's massive forex reserves is necessary and if the reserves are being used efficiently.

China now holds the world's second-largest amount of reserves, jumping by 27 per cent from the end of last year to US$514.5 billion at the end of September.

Some have been calling upon the government to lend some of it to banks and businesses for more efficient use and stronger support to economic growth, although forex authorities had earlier ruled out the possibility, citing the strategic functions of the money.

The rapid forex increases have also complicated China's monetary policy operations, as the central bank needs to buy excess dollar inflows to enforce a narrow band for the renminbi's exchange rate, while increasing money supply at a time of already rapid domestic monetary growth.

Wei also said his administration is considering loosening forex controls as it pushes forward reforms of renminbi convertibility, and measures in the near term will be focused on capital outflow.

(China Daily November 9, 2004)