(Ecns.cn) – The recent U.S. and European debt crises have cast a long shadow over the world's economy, bringing the issue of how to make good use of China's foreign exchange reserves back to the table.
As of June 2011, China's foreign exchange reserves were $3.2 trillion, having grown rapidly from the amount of $2.9 trillion on December 31, 2010.
Last month, Cheng Siwei, economist and ex-deputy chairman of the National People's Congress, pointed out at a forum that the amount of a country's foreign exchange reserves should be about 20% of its gross domestic product (GDP). As China's GDP is currently around $5 trillion, $1 trillion is already sufficient for the country's foreign exchange reserves.
Early in April, Zhou Xiaochuan, the governor of China's central bank, also made it public that the country's foreign exchange reserves had exceeded the appropriate level.
In Cheng Siwei's opinion, holding such a large amount of foreign exchange reserves will exert a great deal of pressure on China's monetary policy. He also suggested that reserves should be more diversified.
Where do the forex reserves come from?
There are two major sources of China's foreign exchange reserves: exports and foreign investment.
In early 1994, China introduced a mandatory system for the settlement and sales of foreign exchange. It stipulated that domestic enterprises must sell excess foreign currency earnings to designated foreign exchange banks. Meanwhile, foreign enterprises must use Chinese currency to invest in China, so they also needed to change their foreign currency at the banks. In this way, the central bank started to stockpile foreign exchange reserves.
With steady growth, the rapid stockpiling gradually led to an excessive accumulation of foreign exchange reserves, drawing public scrutiny of the country's economic policies, as many think the massive holdings are fueling inflation in China.
According to Liu Yuhui, director of the Economic Evaluation Center of the Chinese Academy of Social Sciences (CASS), the previous mandatory system for foreign exchange was abolished on January 1, 2011, so Chinese enterprises can now retain foreign exchange. However, the large amount of reserves is already there. The government must export them by various means such as buying U.S. Treasury bonds and purchasing dollar assets in order recycle them.
