China is diversifying its trillion-dollar foreign reserves by encouraging private investment. But the pressure to appreciate the yuan again and the lack of proper access to global capital markets will prevent individuals from jumping on the wagon anytime soon.

 

The People's Bank of China (PBC), the country's central bank, is increasing the amount of foreign exchange from US$20,000 to US$50,000 that citizens can buy from February 1.

 

"By supporting individuals to hold and use foreign exchange, the new rules aim to help improve the international balance of payment," the State Administration of Foreign Exchange said in a statement on its website.

 

China's foreign exchange reserves have been increasing rapidly because of soaring trade surplus and accelerated foreign direct investment.

 

The latest statistics of the General Administration of Customs show that China's trade surplus rose to a record US$177.5 billion in 2006 from US$101.9 billion in 2005. In addition, the country's actualized foreign direct investment last year rose by 5 per cent to top USUS$63 billion, Commerce Minister Bo Xilai said yesterday.

 

Official figures show China's foreign exchange reserves rose from US$845.2 billion in January 2006 to US$987.9 billion in September. It is widely believed that in the fourth quarter, China's foreign reserves had surpassed US$1 trillion, the highest in the world.

 

The fast accumulation of foreign reserves has forced the PBC to offer more liquidity, adding to worries of credit-driven overheating in the market.

 

"We don't rule out the possibility of using further measures to curb liquidity," PBC governor Zhou Xiaochuan said after raising bank reserve limits four times in seven months.

 

The central bank lifted the reserve requirement by one-half percentage point each in June, July, November and early this month after leaving them unchanged for more than two years. It estimates that every increase of that size reduces the amount available for lending by 150 billion yuan (US$19.25 billion).

 

Now, by relaxing currency controls to make it easier for individuals to buy stocks and bonds abroad, the PBC is trying a new measure to prevent cash from a record trade surplus and continuous capital inflow from going into new loans and overheating the world's fastest-growing economy.

 

In 1998, the quota for individual foreign exchange purchases was only US$2,000. It was raised to US$20,000 last May.

 

Using a conservative estimate that only 0.2 percent of Chinese residents use their quotas to diversify their savings would mean an annual outflow of US$50 billion, a report by the Hongkong Shanghai Banking Corporation (HSBC) said recently.

 

But diversifying the savings of Chinese households still faces strong headwinds.

 

The yuan's exchange rate against the US dollar keeps rising. The yuan ended at 7.8051 against the dollar on the last trading day of 2006. It has appreciated 5.7 per cent since the fixed exchange rate of 8.28 to the greenback was abandoned on July 21, 2005. Amid expectations that the yuan will continue to grow by about 5 percent this year, its exchange rate against the dollar already breached the 7.8 barrier last week.

 

Also, the average Chinese individual lacks access to easier channels to invest in the global capital markets.

 

Since the PBC announced a set of new measures to ease its capital controls, a dozen Chinese banks and other financial institutions have been given the green light to invest up to US$10 billion of their clients' money abroad through the Qualified Domestic Institutional Investor (QDII) scheme. Yet, Hua An Fund Management Co is the only finance firm to get the approval to invest abroad with a limit of US$500 million.

 

"We expect the regulators to take action soon to make QDII (Qualified Domestic Institutional Investor) a more effective channel for outflow, and likely measures include allowing investors to have access to global equity markets through bank QDII (currently limited to fixed-income assets) and increasing QDII quotas for non-bank financial institutions," Qu Hongbin, an HSBC economist, wrote recently to clients.

 

Qu argued that encouraging outflow was the key to introducing two-way flow into the Chinese foreign exchange market the most important pre-condition for China to make a meaningful move toward greater RMB flexibility.

 

(China Daily January 16, 2007)