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China's multi-billion-dollar question

Section: Daily Dispatches

By Richard McGregor
Financial Times, London
Sunday, January 21, 2007

With a vaguely worded statement from Wen Jiabao, China's premier, at the close of a weekend meeting in Beijing on finance policy, the die has been cast for a momentous change in the management of the country's massive foreign exchange reserves.

Mr. Wen said the management of the reserves, the world's largest at more than a thousand billion dollars, should be improved and the channels through which they are invested diversified.

Such remarks might seem to be little more than common sense but, against the backdrop of an intense, year-long debate in China about how to use the money, Mr. Wen's remarks represent a decisive policy shift.

Everyone from senior leaders to local policy entrepreneurs has been floating ideas about how to use the money, ranging from funding education and health systems to buying foreign oil and stocks. Such policy proposals can now be put forward for possible adoption.

Once a plan has been implemented, in five to 10 years, Beijing could preside over one of the world's largest and most powerful investment agencies.

The debate thus far has irritated some economic policymakers who testily point out that the reserves cannot simply be spent as they represent assets on the central bank's balance sheet.

The government, or some agency under its control, would have to account for the funds in some fashion, perhaps through the issuance of bonds to the People's Bank of China.

But the PBoC has already used $60 billion (46 billion euros, 30 billion pounds) to recapitalise the big state banks through Central Huijin Investment, the holding company for state assets under its control. That bailout set a precedent that others are keen to follow.

Mr. Wen did not endorse any specific plan but has indicated the government will consider proposals on how to use some of the money -– now mostly locked up in US Treasury bonds –- more aggressively.

Initial projections for the amount of money that could be more actively managed are $200 billion to $300 billion but Mr. Wen shed no light on this.

"China will diversify the use of its reserves but, as to how it is actually done, there are still some different ideas," said Ha Jiming, an economist with China International Capital Corp., a local investment bank. "There will almost certainly be some outsourcing as a result -– it's difficult for the government to manage the reserves this way and invest abroad."

The government will take some time to sort through the bureaucratic competition developing round a plan to establish a state body to oversee any investment of the reserves.

Huijin has long been discussed as a potential vehicle but the Ministry of Finance, which sees the reserves as its to manage, is battling to establish a role for itself in any new agency.

Mr. Wen said at the meeting's close that China should take "various measures to improve the basic balance of international payments" -- a statement just as important as the issue of reserves management.

Beijing's reserves could double within four years based on current projections, driven mainly by an ever-expanding trade surplus.

As long as Beijing maintains its present posture of allowing only an incremental appreciation of its currency, the renminbi, and runs a large trade surplus, its reserves will continue to balloon.

Beijing's policy has long been to have its global trade basically balanced but announcements recommitting the country to such a path have reached a peak in recent weeks.

Such statements appear to reflect rising awareness in Beijing of growing impatience in Washington and Brussels, where perceptions that China is pursuing unfair trade policies are hardening.

Combined with suspicions about China's geopolitical ambitions, a failure to address such perceptions risks political confrontation between China and the US and Europe.

Such tensions could also have a practical impact on China's ambitions to put its reserves to better use and the West's efforts to bring Beijing closer into the prevailing global order.

In a hostile world, the US and Europe might not welcome Chinese investments, especially the purchase of assets such as raw materials.

That would propel China to look for more properties in countries such as Sudan and Iran -– a path that would raise tensions even further.

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