With foreign exchange reserves worth US$853.6 billion at the end of February, China now has the world's largest forex reserves, surpassing Japan, the State Administration of Foreign Exchange (SAFE) confirmed recently.

With less than US$10 billion in reserves in the early 1980s, the massive growth in this area reflects China's developing robust national economy. However, experts still debate if having such a colossal forex reserve holding is necessarily a good thing.

More symbolic significance than practical application

It came as no surprise that China would eventually amass the world's largest forex reserves. In the last two years, annual increments amounted to US$200 billion. By the end of 2005, China had US$818.9 billion in forex reserves, still tens of billions less than Japan, then the country with the largest forex reserves. Japan's reserves in February 2006 decreased by US$1.6 billion, while China maintained its steady growth.

"Being the world's largest holder of foreign exchange reserves is nothing but a title, and its symbolic significance is greater than its practical application," said Xu Hongyuan, a researcher from the State Information Center, a governmental think-tank.

Wu Xiaoling, vice governor of the People's Bank of China (PBC), China's central bank, said recently that there is no scientific method of measuring what value of reserves is good for a country, and it would not be accurate to merely make straightforward comparisons between countries.

According to official statistics, per capita forex reserves in China are estimated to be just over US$600, less than one tenth of Japan's, and also far less than countries such as Singapore. "China's foreign exchange reserves are not big if measured in per capita terms," PBC Governor Zhou Xiaochuan said.

No joy without annoy

Experts acknowledge that some forex reserves are necessary for strengthening a country's macro control ability and fending off international financial risks. According to Dr. Mei Xinyu, a researcher from the Chinese Academy of Foreign Trade and Economic Cooperation under the Ministry of Commerce, a healthy reserves balance for China means it is able to make international payments and to tide itself over in the event of debt crises, negative effects of speculative funds trading or a sudden drop in exports to the international market.

Forex reserves can be used to reduce any negative impacts on supply and demand in the domestic market, and help maintain the normal operations and steady development of the national economy.

But just how much does a country need in forex reserves to do all this? According to Zhao Peng, president of the Industrial and Commercial Bank of China (ICBC) Gansu Branch, reserves should be able to sustain imports for at least three months. According to international practice, foreign exchange reserves should be no less than 30 percent of foreign debts. In 2005, China's imports valued about US$660.1 billion, while its foreign debt was US$250 billion. Taking into account factors including profits remitted out of the country by foreign-funded enterprises, and forex demands for financial reform, reserves in China should ideally be no more than US$550 billion.

Current reserves far exceed that amount

As far as forex reserves are concerned, more isn't necessarily better. Oversized reserves will put more pressure on financial macro control and could harm economic development. It could also lead to more trade frictions and give other countries an edge against China. The management of oversized reserves also becomes increasingly difficult.

As some experts point out, an increase in currency supplies can restrict the use and effects of monetary policies. Foreign currencies bought and held are shown as renminbi (RMB) equivalents in the accounts books of the State Administration of Foreign Exchange. An increase in forex means an increase in RMB supplies. This affects prices, monetary authorities' ability to control currency inflow, and the effectiveness of monetary policies.

In addition, a huge forex reserve lowers capital utilization efficiency and correspondingly results in wastage. At the same time, the costs and risks of keeping forex are also raised.

China isn't in blind pursuit of bursting forex reserves, Wu Xiaoling told Xinhua News Agency in a recent interview. In fact, exchange rate reforms mean that the central bank will play a gradually less involved role as foreign exchange market watchdog, depending on actual conditions. Simultaneously, it is working towards reducing the growth of the country's forex reserves, a clear indication that it will be paying more attention to economic benefits and quality as opposed to blindly expanding its forex coffers.

China's healthy forex reserve balance is a reflection of its economic might. However, that strength is more a result of the quantity of exports rather than a highly efficient production capability. Rising trade surpluses and disputes all call for a major overhaul of the country's foreign trade model and indeed its economic structure.
 
On that front, SAFE has indicated that it will actively explore ways of better utilizing forex reserves this year, further optimize currencies and assets, and continue broadening investment fields.

The four growth phases in China's forex reserves development:

1978 - 1993: 
Reserves were only US$1.6 billion in 1978. After the reform and opening up policy was subsequently adopted, the figure gradually increased through more export-boosting and import-controlling efforts. In 1983, reserve reached US$8.9 billion. However, this was thought too high, and was sharply slashed to US$2.1 billion in 1986. In the following years, the reserve gradually rebounded and stabilized at between US$10 billion and US$20 billion.

1994 - 1997:  
In 1994, China's foreign exchange management system underwent great reform: exchange rate systems were unified; a company's right to collect payment in foreign exchange earnings was withdrawn; banks were authorized to settle and sell foreign exchange; and an inter-bank foreign exchange trading market was established. Such measures enabled the country's forex reserves to increase comparatively quickly. Reserves rose 5.6 times to US$139.89 billion at the end of 1997 from US$21.199 billion in 1993.

1998 - 2000:
As a result of the Asian financial crisis in 1997, the growth of China's foreign exchange reserves slowed down significantly. From 1998 to 2000, the increment was US$5.097 billion, US$9.715 billion and US$10.899 billion respectively. They were only 14.62 percent, 27.87 percent and 31.27 percent of increments in 1997. Nevertheless, China still managed to accumulate US$165.574 billion by the end of 2000, and became one of the world's largest holders of foreign exchange.

2001 - present:
Since 2001, China's forex reserves have grown at a startling rate. From 2001 to 2005, increment of reserves was US$46.591 billion, US$74.242 billion, US$116.844 billion, US$206.681 billion and US$209 billion respectively. As at the end of February, they were US$853.6 billion.

(China.org.cn by Tang Fuchun, April 10, 2006)