E-Paper
China?s one trillion dollar clout
It is unlikely that China will use its clout to influence the market as its own reserves will fall short, reports DH Pai Panandiker.
The foreign exchange reserves of China crossed $1 trillion (Rs 450 lakh crore) this month taking it ahead of Japan's.
The reserves are much larger than what is required to provide a backup to the currency or fund unexpected import shortfalls. This tremendous financial clout, if actively used, can upset international exchange rates, interest rates and commodity prices.
Even the developed countries do not have foreign exchange reserves comparable to China’s. The United States reserves are a mere $54 billion, United Kingdom’s $43 billion, Germany’s $43 billion and so on. It is only Japan which holds large reserves amounting to $837 billion.
The reserves, by themselves, do not reflect the strength of the economy or of the currency. The difference between the developed countries and China is that the former have freely convertible currencies and as such foreign assets are held not only by the central banks but also by private institutions and individuals.
The central banks hold reserves only to intervene in the currency market whenever the need arises. China’s central bank has accumulated reserves because its private sector cannot hold assets overseas.
The Bank buys foreign exchange earned by exporters or remitted by non-resident Chinese or foreign investors in exchange for yuan and keeps it closely tied to the dollar.
India follows a similar policy which has helped the Reserve Bank of India (RBI) to accumulate $166 billion reserves.
But the rupee is much more flexible than the yuan and our external trade has been in the deficit. The reserves have been accumulated largely from foreign investment and NRI deposits and are therefore more vulnerable.
The reserves with China have been largely invested in dollar and euro securities. Although the pattern of investment is a closely guarded secret, it is believed that 70 per cent of the reserves are in dollar securities, 20 per cent in euros and 20 per cent in yen and other currencies.
The most favoured investment is in US treasuries which means that China is funding a large part of US budget deficit.
What worries the market is a change in the investment pattern of its reserves by China.
If, for instance, China invests less in dollar securities in order to diversify its portfolio, the demand for US treasuries will fall, their prices will drop and consequently the long rate of interest in the US will rise.
It is precisely the huge demand for treasuries by China and Japan that prevented a rise in the long rate even when the Fed increased short rate interest from 1.5 to 5.25 per cent in the last three years.
The other outcome of a change in the reserves portfolio by China would be a fall in the dollar in terms of the euro and the yen.
Even rumours about a change have been responsible for the fall of the dollar or rise in the prices of gold.
But it appears unlikely that China will use its clout to influence the market for the simple reason that a fall in the dollar will reduce the value of its own reserves.
