China moves to explain $136 billion FX surge


By Richard McGregor
Financial Times, London
Monday, April 16, 2007

BEIJING -- China has taken the unusual step of trying to explain the recent surge in its foreign exchange reserves after they rose by the equivalent of $1 million a minute in the first quarter of this year, or by more than half the total increase of 2006.

The explanation on Monday by Wu Xiaoling, a deputy governor of the People's Bank of China, prompted a number of analysts to firm up their expectations that the central bank would introduce further monetary tightening measures.

Economists also expect first-quarter economic growth figures, due to be released on Thursday, to put more pressure on the PBoC. Goldman Sachs, in a note to investors, on Monday said it expected gross domestic product growth for the first quarter of 2007 to accelerate to 11.2 percent, up from 10.4 percent in the final three months of last year.

China has already increased six times in less than a year the amount it requires commercial banks to keep on deposit with the authorities, to control liquidity in the financial system. It has increased interest rates three times during the same period.

Beijing supports fast growth but has been increasingly worried about the political, environmental, and structural economic impact of the current model, which is driven by high net exports and energy-intensive heavy industry.

Speaking at a seminar in Guangzhou, southern China, on Sunday, Ms. Wu said the first-quarter rise in foreign exchange reserves of $135.7 billion (100 billion euroes, £68 billion) to $1,202 billion was caused by a number of factors beyond the sharp rise in the trade surplus, which had already been made public.

Ms. Wu said the unwinding of swap agreements between the central banks and Chinese commercial lenders had resulted in foreign exchange coming back on to the PBoC's books.

Some of the funds raised in huge offshore initial public offerings by Chinese banks and other enterprises had also been brought back onshore, driven by the desire to take advantage of the rising renminbi.

"Recently, due to an expectation of the [continued] revaluation of renminbi, these enterprises have rushed to settle their foreign exchange holdings through various arrangements and bring [the funds] back onshore," she said.

Four of China's five large state banks have raised $42 billion in offshore IPOs in the past 22 months, with Industrial and Commercial Bank of China alone raising a world record $21.9 billion last October.

Ms. Wu's explanation seems designed to kill off any suggestions that the increase in reserves was due to a renewed surge in inflows of speculative "hot money" out of the control of the authorities.

Stephen Green of Standard Chartered bank in Shanghai cited a number of other factors responsible for higher reserves, notably interest earned on existing holdings and the impact of currency revaluations on its portfolio of currencies.

It is not clear why the PBoC decided to unwind the swaps with the commercial banks but they may have done so under pressure from the lenders, who thought the money could be used more profitably at home.

Mr. Green also speculated that the PBoC wanted to bring all outstanding funds back onshore ahead of the establishment of the proposed new body to manage a portion of the reserves and secure higher returns.

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