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October 31, 2007 -- The SAFE recently released China's Balance of Payments Statement for the first half of 2007. Statistics reveal that the current account and the capital and financial account posted a "twin surplus",and international reserves increased rapidly. In the first half of 2007, China's surplus under the current account totaled USD 162.9 billion. Specifically, according to the statistical coverage of the balance of payments, the surpluses in goods, income, and current transfers reached USD 135.7 billion, USD 12.9 billion, and USD 17.4 billion, respectively, while the deficit in services amounted to USD 3.1 billion. Meanwhile, China's surplus under the capital and financial account totaled USD 90.2 billion. In particular, net inflows of the capital account, direct investments, and other investments reached USD 1.5 billion, USD 50.9 billion, and USD 42.6 billion respectively, while the outflows of portfolio investment totaled USD 4.8 billion. Furthermore, China's international reserves continued to grow. At the end of June, China registered a total of USD 1,332.6 billion in foreign exchange reserves, an increase of USD 266.3 billion over the end of 2006. In addition, the BOP Analysis Team of the SAFE released China's Balance of Payments Report for the First Half of 2007 in order to facilitate understanding of the data and analysis of China's balance of payments among all social groups. Chinas Balance of Payments * (First Half of 2007) (Unit: 1,000 US dollars) Item Line Balance Credit Debit I. Current Account 1 162,857,962 656,184,959 493,326,998 A. Goods and Services 2 132,549,018 603,062,616 470,513,597 a. Goods 3 135,690,881 547,174,215 411,483,334 b. Services 4 -3,141,862 55,888,401 59,030,263 1.Transportation 5 -4,843,018 13,554,628 18,397,646 2.Travel 6 3,341,977 17,935,000 14,593,023 3.Communication Services 7 125,237 592,293 467,057 4.Construction Services 8 619,002 1,878,559 1,259,557 5.Insurance Services 9 -4,336,191 482,745 4,818,936 6.Financial Services 10 -218,799 76,406 295,205 7.Computer and Information Services 11 971,409 1,948,049 976,640 8.Royalties and Licensing Fees 12 -3,833,739 114,902 3,948,641 9.Consulting Services 13 -196,482 4,941,825 5,138,307 10.Advertising and Public Opinion Polling 14 295,104 875,640 580,536 11.Audio-visual and Related Services 15 31,048 92,700 61,652 12.Other Business Services 16 4,903,403 13,035,673 8,132,270 13. Government Services, n.i.e. 17 -814 359,980 360,794 B. Income 18 12,904,373 34,083,181 21,178,808 1.Compensation of Employees 19 1,716,895 2,972,999 1,256,105 2.Investment Income 20 11,187,478 31,110,182 19,922,704 C. Current Transfers 21 17,404,571 19,039,163 1,634,592 1.General Government 22 -83,230 21,191 104,421 2.Other Sectors 23 17,487,801 19,017,972 1,530,171 II. Capital and Financial Account 24 90,164,499 446,812,821 356,648,322 A. Capital Account 25 1,464,582 1,563,893 99,311 B. Financial Account 26 88,699,916 445,248,928 356,549,011 1. Direct Investment 27 50,919,043 63,314,553 12,395,510 1.1 Abroad 28 -7,414,240 585,653 7,999,892 1.2 Domestic 29 58,333,282 62,728,900 4,395,618 2. Portfolio Investment 30 -4,825,693 17,686,641 22,512,334 2.1 Assets 31 -15,077,372 7,434,962 22,512,334 2.1.1 Equity Securities 32 -5,034,000 927,000 5,961,000 2.1.2 Debt Securities 33 -10,043,372 6,507,962 16,551,334 2.1.2.1 Bonds and Notes 34 -8,175,372 6,507,962 14,683,334 2.1.2.2 Money Market Instruments 35 -1,868,000 0 1,868,000 2.2 Liabilities 36 10,251,678 10,251,678 0 2.2.1 Equity Securities 37 10,251,678 10,251,678 0 2.2.2 Debt Securities 38 0 0 0 2.2.2.1 Bonds and Notes 39 0 0 0 2.2.2.2 Money Market Instruments 40 0 0 0 3. Other Investment 41 42,606,567 364,247,734 321,641,167 3.1 Assets 42 17,149,666 31,767,204 14,617,538 3.1.1 Trade Credits 43 -5,915,000 0 5,915,000 Long-term 44 -414,050 0 414,050 Short-term 45 -5,500,950 0 5,500,950 3.1.2 Loans 46 12,235,115 14,539,086 2,303,972 Long-term 47 -1,041,000 0 1,041,000 Short-term 48 13,276,115 14,539,086 1,262,972 3.1.3 Currency and Deposits 49 9,227,109 13,212,830 3,985,722 3.1.4 Other Assets 50 1,602,443 4,015,287 2,412,844 Long-term 51 0 0 0 Short-term 52 1,602,443 4,015,287 2,412,844 3.2 Liabilities 53 25,456,901 332,480,530 307,023,629 3.2.1 Trade Credits 54 7,132,000 7,132,000 0 Long-term 55 499,240 499,240 0 Short-term 56 6,632,760 6,632,760 0 3.2.2 Loans 57 10,192,989 279,836,819 269,643,829 Long-term 58 2,381,266 10,091,536 7,710,271 Short-term 59 7,811,724 269,745,283 261,933,559 3.2.3 Currency and Deposits 60 8,247,446 44,741,749 36,494,304 3.2.4 Other Liabilities 61 -115,534 769,962 885,496 Long-term 62 278,404 309,958 31,554 Short-term 63 -393,938 460,004 853,942 III. Reserves Assets 64 -266,097,901 219,340 266,317,242 3.1 Monetary Gold 65 0 0 0 3.2 Special Drawing Rights 66 -36,242 0 36,242 3.3 Reserves Position in the Fund 67 219,340 219,340 0 3.4 Foreign Exchange 68 -266,281,000 0 266,281,000 3.5 Other Claims 69 0 0 0 IV. Net Errors and Omissions 70 13,075,441 13,075,441 0 * This BOP statement employs rounded-off numbers. 2007-10-31/en/2007/1031/860.html
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November 26, 2007 -- Ms. Hu Xiaolian, deputy governor of the People's Bank of China and administrator of the State Administration of Foreign Exchange (SAFE), recently conducted research and investigation in Guangdong province on the implementation of the guiding principles of the Seventeenth National Congress of the CPC, the enhancement and improvement of foreign exchange management, and the promotion of an equilibrium in the balance of payments. During her research and investigation, Hu and her colleagues held symposia with the Guangdong branch and some central sub-branches of the SAFE, and paid visits to locally designated foreign exchange banks and enterprises. Guangdong province, with its developed export-oriented economy, ranks top in China in terms of its foreign trade and utilization of foreign capital; in particular, its foreign exchange business accounts for one-third of the state's total. Hu listened carefully to analyses on the current situation of foreign trade, foreign capital, and foreign exchange receipts and payments, with a focus on the administration of foreign exchange in trade, foreign capital and external debts, and overseas investment, the attack on underground money shops, and so on. In order to facilitate the production and operation of foreign trade enterprises and to effectively monitor the foreign trade activities and the authenticity of foreign exchange receipts and payments, foreign exchange administrative departments have carried out systematized administration over the import and export enterprises. Guangdong branch has employed a "Dynamic Monitoring and Managing System for Foreign Exchange Inflows" in regions under its governance, and has greatly enhanced the efficiency of systematized administration. While inspecting the results of the application of this system, Hu expressed great affirmation and appreciation for the innovative work of the Guangdong and Shenzhen branches. She pointed out that the introduction of this system can enable real-time tracking of the match between foreign exchange receipts and payments of enterprises and their foreign trade activities, as well as enhance monitoring efficiency. On this basis, follow-up monitoring work should be strengthened to urge enterprises to handle foreign exchange receipts and payments in accordance with the laws and regulations and to correct problems in a timely manner. Furthermore, those enterprises experiencing a serious conflict between capital flows and the actual situation of import and export activities should be listed as "highlighted enterprises" for intensified pre-supervision. In recent years, the foreign exchange administrative departments of Guangdong province, in close cooperation with the public security agencies, have reinforced efforts to crack down on underground money shops and illegal foreign exchange transactions, and have destroyed many such shops and dens. Hu specified that cases of underground money shops should be treated with different measures according to the specific situations, and both guidance and punishment should be adopted. Cooperation with the public security agencies should be continuously promoted to strongly fight against those conducting illegal activities such as gambling, smuggling, tax evasion, and money laundering through underground money shops. The quality and level of financial services should be earnestly improved to enhance the competitiveness of business procedure fees, timeliness, and so on. Further reforms should be advanced in order to keep pace with the times, to meet demands for the holding and utilization of foreign exchange by domestic institutions and residents, and to loosen controls on individual foreign investments in an orderly, controllable, and moderate manner. Publicity and education should be strengthened so as to enhance the law-abiding consciousness of domestic institutions and residents to handle foreign exchange business through formal financial institutions. When visiting the designated foreign exchange banks and enterprises, Hu expressed appreciation for their cooperation with the foreign exchange administration. Meanwhile, she pointed out that supervision of China's current foreign exchange administration is mainly carried out through subrogation by designated foreign exchange banks, so the banks should, while offering high- quality services to customers, adhere to the relevant regulations on foreign exchange administration, balance appropriately among management, competition, and profits, and thus contribute to the economic and financial security of the state. Hu emphasized that the foreign exchange administrative departments at all levels should study and carry out the guiding principles of the Seventeenth National Congress of the CPC, earnestly unify their thoughts with the spirit of the CPC Central Committee, consider the actual situation of foreign exchange administration, fully implement the scientific development concept, and promote an equilibrium in the balance of payments. 2007-11-26/en/2007/1126/861.html
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December 9, 2007 -- Remarkable progress has been made since China launched its pilot projects for the Qualified Foreign Institutional Investors (QFII) and Qualified Domestic Institutional Investors (QDII) systems in 2002. The QFII system has promoted the transformation of investment concepts in China's capital market and the application of advanced investment risk management technologies, raised the global influence of China's capital market, and played an active role in the improvement of the governance structure of domestic listed companies, the sound development of the market, as well as the institutional reform and innovation of the capital market. The market capitalization of securities held by 49 QFIIs has reached nearly RMB 200 billion, making them the main institutional investors in China 's capital market. The QDII system has expanded the investment channels for domestic capital, enabling domestic investors to reasonably allocate their assets throughout the world and to reduce investment risks. Moreover, the system has directed the orderly outflow of capital and promoted an equilibrium in the balance of payments. Currently, all qualified commercial banks, insurance companies, fund companies, and securities companies can conduct QDII business, gradually diversifying the members of the QDII system. In particular, with the release of QDII products by fund companies in September, the QDII business has entered a phase of rapid development. To deepen the opening up of China 's capital market, the investment quota for QFII has been increased to USD 30 billion. Based on the status of China 's balance of payments and the situation of the securities market, together with the relevant departments the SAFE will control the speed of the examination and approval process of new QFII quotas and will encourage investment of qualified foreign medium- and long-term capital into China 's capital market. In addition, the SAFE will expand overseas securities investment by domestic residents, increase foreign securities investment by QDIIs, encourage qualified domestic financial institutions to raise their competitiveness, provide more diversified products that satisfy the needs of domestic investors, and enhance the level of risk management, thus gaining new dominance from participation in global competition under the conditions of economic globalization. 2007-12-09/en/2007/1209/862.html
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September 29, 2007 -- At the end of June 2007, China 's outstanding external debt (excluding that of Hong Kong SAR, Macao SAR, and Taiwan Province , the same as below) reached USD327.802 billion, an increase of USD 4.814 billion or 1.49% compared with that at the end of 2006. Specifically, the outstanding long- and medium-term external debt (with the remaining term) reached USD 142.933 billion, an increase of USD 3.573 billion or 2.56% compared with that at the end of 2006, accounting for 43.60% of the total outstanding external debt; the outstanding short-term external debt (with the remaining term) totaled USD 184.869 billion, an increase of USD 1.241 billion or 0.7% compared with that at the end of 2006, accounting for 56.40% of the total outstanding external debt. Among China 's total outstanding external debt, the outstanding registered external debt reached USD 216.702 billion and the balance of trade credit was USD 111.1 billion. Among the outstanding registered external debt, the outstanding sovereign debt borrowed by ministries under the State Council was USD 34.608 billion, accounting for 15.97%; the outstanding debt of Chinese-funded financial institutions was USD 70.648 billion, accounting for 32.60%; the outstanding debt of foreign-funded enterprises was USD 64.036 billion, accounting for 29.55%; the outstanding debt of foreign-funded financial institutions in China was USD 43.843 billion, accounting for 20.23%; the outstanding debt of Chinese-funded enterprises was USD 3.282 billion, accounting for 1.52%; and the outstanding debt of other institutions was USD 285 million, accounting for 0.13%. From January to June 2007, long- and medium-term external borrowing was USD 15.369 billion, an increase of USD 5.492 billion or 55.60% over the previous year. The principal repayment was USD 11.005 billion, an increase of USD 2.653 billion or 31.76% over the previous year. The interest payment was USD1.740 billion, an increase of USD 622 million or 55.64% over the previous year. In the first half year of 2007, the growth rate of Chinas external debt slowed down, and the outstanding registered external debt witnessed negative growth for the first time in the past five years, with the short-term registered external debt dropping greatly and the share of the short-term external debt declining for the first time. 2007-09-29/en/2007/0929/856.html
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At the end of September 2007, China 's outstanding external debt (excluding that of Hong Kong SAR, Macao SAR, and Taiwan Province ) reached USD345.705 billion, an increase of USD 22.717 billion or 7.03% compared with that at the end of 2006. Specifically, the outstanding long- and medium-term external debt (with the remaining term) reached USD 148.047 billion, an increase of USD 8.687 billion or 6.23% compared with that at the end of 2006, accounting for 42.82% of the total outstanding external debt; the outstanding short-term external debt (with the remaining term) totaled USD 197.658 billion, an increase of USD 14.03 billion or 7.64% compared with that at the end of 2006, accounting for 57.18% of the total outstanding external debt. Of China 's total outstanding external debt, the outstanding registered external debt reached USD 226.005 billion and the balance of trade credit was USD 119.7 billion. Of the outstanding registered external debt, the outstanding sovereign debt borrowed by ministries and commissions of the State Council was USD 34.612 billion, accounting for 15.31%; the outstanding debt of Chinese-funded financial institutions was USD 73.175 billion, accounting for 32.38%; the outstanding debt of foreign-funded enterprises was USD 67.616 billion, accounting for 29.92%; the outstanding debt of foreign-funded financial institutions in China was USD 45.576 billion, accounting for 20.17%; the outstanding debt of Chinese-funded enterprises was USD 4.737 billion, accounting for 2.09%; and the outstanding debt of other institutions was USD 289 million, accounting for 0.13%. From January to September 2007, the long- and medium-term external debt was USD 25.472 billion, an increase of USD 7.65 billion or 42.92% over that in the previous year. The principal repayment under the long- and medium-term external debt was USD 14.761 billion, an increase of USD 2.287 billion or 18.33% over that in the previous year. The interest payment was USD 2.666 billion, an increase of USD 817 million or 44.19% over that in the previous year. 2007-12-29/en/2007/1229/863.html
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China International Fund Management Co., Ltd's purchasing quota of foreign exchange for overseas portfolio investment increased 2007-10-18/en/2007/1018/858.html
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China International Fund Management Co., Ltd's purchasing quota of foreign exchange for overseas portfolio investment approved 2007-10-12/en/2007/1012/857.html
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HSBC's purchasing quota of foreign exchange for overseas investment services on behalf of its clients increased 2007-10-27/en/2007/1027/859.html
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Editors Note: As an important part of foreign-related economic and financial activities, foreign exchange management has always been in the spotlight. The State Administration of Foreign Exchange (SAFE), in an attempt to communicate with the public, increase the transparency of policies and management, and facilitate and enhance public understanding of foreign exchange management, has extensively surveyed and collected issues of common concern in the media and among the public and has compiled a list of frequently-asked questions on foreign exchange management policies. These questions will be answered in succession in future issues for public discussion and reference. Q1: How did Chinas foreign exchange reserve assets come into existence? Can these assets be allocated for free? A: Foreign exchange is bought and sold by businesses and individuals through the commercial banks. If such foreign exchange is sold by commercial banks on the interbank market and bought by the Peoples Bank of China (PBOC), it becomes part of the foreign exchange reserves. When the PBOC buys foreign exchange, it pays the equivalent amount in RMB to the holder of the foreign exchange. There are three main channels from which foreign exchange flows: The first is businesses. When companies provide goods or services to foreign customers or accept foreign investment, they are paid in foreign exchange, which can then be converted into RMB in commercial banks before it is used in China. During the exchange settlement, the companies sell the foreign exchange to the commercial banks in exchange for an equivalent amount of RMB, thereby converting their foreign currency assets into RMB assets at the current exchange rate. The second channel is individuals, who sell their foreign exchange to the commercial banks in exchange for an equivalent amount of RMB. The third is commercial banks. After buying foreign exchange from businesses and individuals, the commercial banks, as required according to the foreign exchange asset liability allocation, will resell the foreign exchange to businesses and individuals in various business outlets and will sell the remaining foreign exchange to the PBOC in exchange for an equivalent amount of RMB. Taken as a whole, during the formation of the foreign exchange reserves, businesses, individuals, and banks are not handing over their foreign exchange to the state without compensation; instead, they are selling their foreign exchange to the state in exchange for an equivalent amount of RMB. This is completely different from taxation and fiscal revenue. It should be emphasized that all these transactions are conducted in an equivalent and voluntary manner. The economic interests of the banks, businesses, and individuals are realized when their foreign exchange is converted into RMB and the PBOC acquires this foreign exchange by paying the corresponding amount in RMB. The formation of foreign exchange assets comes with a cost; therefore, they cannot be allocated for free. Q2: How can foreign exchange reserves support the development of the domestic economy? A: Foreign exchange reserves play an important role in the development of Chinas domestic economy because, first of all, an abundant amount of foreign exchange reserves is conducive to safeguarding Chinas economic and financial security. In recent years, we have witnessed the benefits of keeping a large amount of foreign exchange reserves, in terms of maintaining the capacity for international payments, guarding against financial risks, upholding national economic and financial security, and robustly supporting the healthy and stable development of our national economy. After the outbreak of the recent international financial crisis, foreign exchange reserves played a prominent role in cushioning the blow of the external disturbances. Second, sufficient foreign exchange reserves can facilitate foreign-related economic activities of businesses. Only when there are sufficient foreign exchange reserves can enterprise demands for the use and purchase foreign exchange be fulfilled. If a company wants to invest in a foreign country, as long as the company is economically viable it can make the investment after purchasing foreign exchange with RMB. In this sense, the foreign exchange reserves can guarantee abundant funding for the going global initiatives of Chinese enterprises. Similarly, companies are given guarantees and support when they have to pay for foreign goods or debts. Third, the operating profits from foreign exchange reserves can increase expenditures for the peoples livelihood. The responsibility of the foreign exchange management departments is to ensure, in addition to risk management, maintenance of the value of the assets and an increment in the foreign exchange reserves. The operating profits of foreign exchange reserves are incorporated into the overall account of the PBOC, as part of the net profits of the central bank that will be fully turned over to the state treasury. This will increase the availability of funds used to improve the peoples livelihood, which in effect will constitute a boost to national welfare. In discussions of how foreign exchange reserves can support the development of the domestic economy, two issues need to be clarified. First, foreign exchange reserves cannot be used without compensation. Unlike fiscal funds, foreign exchange reserves are created when the PBOC purchases foreign exchange with RMB on the domestic or international foreign exchange markets and the reserves are closely related to the currency issuances and RMB liabilities of the PBOC. If foreign exchange reserves were to be allocated for free use, the balance sheet of the PBOC would be affected, generating inflationary pressures and threatening economic and financial stability. The second issue is that foreign exchange reserves consist of foreign exchange, which is mainly used for foreign payments. For the foreign exchange reserves to be used domestically, they have to be reconverted into RMB, which will require that more currency is issued, thus aggravating the surplus of domestic liquidity. Q3: What is the appropriate scale for Chinas foreign exchange reserves? A: Too much foreign exchange reserves can be bad. We are not seeking to build up large volume of foreign exchange reserves nor a long-term surplus in our international balance of payments. Chinas current account and capital account have maintained a multi-year surplus, and the growth of our foreign exchange reserves is the objective result of the twin surplusin the international balance of payments, reflecting the long-term stable growth of the Chinese economy. In fact, this is determined by the current stage and characteristics of Chinas economic development. Our abundant foreign exchange reserves can ensure a stable financial environment. As a large developing country, we need to maintain a certain scale of foreign exchange reserves, even for what has traditionally been considered moderate. In addition, maintaining sufficient foreign exchange reserves can also boost our confidence. As has been amply proved during the recent international financial crisis, a sufficient amount of foreign exchange reserves can put us in a better position to effectively fend off future crises. In terms of aggregate foreign exchange assets, in a broad sense, at year-end 2009, China held USD 3.46 trillion in foreign financial assets, far lower than the developed countries in North America and Europe. The main problem at present is that most of Chinas foreign exchange assets are controlled by the government, leaving only a small proportion in private hands. Specifically, foreign exchange reserves held by the Chinese government account for two-thirds of all foreign assets in China, compared with only one-sixth in Japan. Therefore, we encourage businesses and individuals to hold and invest in foreign exchange so as to diversify the mix and to distribute foreign exchange within the private sector. This, of course, takes time. With the development of our national economy and the increase in income, enterprises and individuals will have greater demands for diversification of asset allocations. If more foreign exchange investment channels and products are provided for the public to reap concrete benefits from the foreign exchange, then the foreign exchange pressures on the government will be greatly relieved. Q4: What currencies are included in Chinas foreign exchange reserves? How are they structured? A: Chinas foreign exchange reserves include the major currencies, for instance the US dollar, the euro, and the Japanese yen, as well as the currencies of some emerging economies. This is a generally loose composition of currency. The currency composition of the foreign exchange reserves is designed to facilitate Chinas foreign-related economic activities. It takes into consideration Chinas foreign payment structure that encompasses foreign trade, foreign debt, and direct investment, as well as the currency structure of global foreign exchange reserves, so that the risks can be diversified against dynamic developments of various currencies and so that demands for foreign payments and asset allocations can be better fulfilled. The currency composition does not remain static. It is dynamically adjusted and optimized to respond to market volume, liquidity, the risk-return characteristics and development trends of the currencies, and changes in the economies and markets, as well as in response to investment demands. Q5: In the operation and management of the foreign exchange reserves, how can we ensure the openness and transparency of market information and compliance with investment and operations rules?? A: At present, the foreign exchange reserves of China follow the information disclosure requirements of the IMFs General Data Dissemination System (GDDS), which is the common practice in most countries. In recent years, efforts have been made to enhance the transparency of information on the foreign exchange reserves. For example, the Overview of Chinas Foreign Exchange Administration was issued in 2009, in which one entire chapter is devoted to presenting a relatively comprehensive introduction to the operations and management of the foreign exchange reserves. In addition, when the 2009 Balance of Payments Statement was formulated and published, the statistical method for the foreign exchange reserve assets was further improved to increase transparency. This being said, the increase in information transparency on the foreign exchange reserves should be carried out in a prudent and measured manner. As the large scale of Chinas foreign exchange reserves lends significant weight to Chinas position in international financial markets, any information disclosed about investments might give rise to market turbulence and cripple our investment activities. Most countries choose to be very careful when disclosing information related to foreign exchange reserves. Specific transactions are generally not disclosed to the public and are not required to be disclosed by the data dissemination standards of the relevant international organizations. To ensure the safety, liquidity, value maintenance, and increment in our foreign exchange reserves, we have established a comprehensive set of investment decision-making processes and various risk management and internal control systems, which have been developed to guarantee appropriate and effective progress in reserve operations and management. Reserve operations are regularly subject to audits by the relevant departments. Furthermore, any comments and suggestions from different sectors are highly valued, investigated in a timely and in-depth manner, and kept as reference for the operation and management of the foreign exchange reserves. (To be continued) 2010-07-02/en/2010/0702/936.html
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Yi Gang, deputy governor of the People's Bank of China (PBOC) and administrator of the State Administration of Foreign Exchange (SAFE), recently accepted an interview with Hu Shuli, executive editor-in-chief of China Reform. The interview, published in issue no. 8 (2010) of China Reform and appearing on www.caing.com, is presented here as follows. The Best Choice for the RMB Exchange Rate Regime Ultimate Goal and Timetable Hu Shuli (hereinafter referred to as Hu): On June 19, 2010, the Peoples Bank of China announced the decision to further the reform of the RMB exchange rate formation mechanism on the basis of the 2005 reform. Why now? What do you think of the achievements that the exchange rate reform has made so far? Yi Gang (hereinafter referred to as Yi): Chinas exchange rate regime is a floating one, which is based on market supply and demand and subject to adjustment and management against a basket of currencies. In fact, this is the best choice at present for the Chinese socialist market economy. How have we arrived at this conclusion? The reform of the exchange rate regime began in 1994, when exchange rates were unified on January 1 and the foreign exchange market was established soon thereafter. From 1994 to 1996, the RMB fluctuated in both directions and appreciated by about 5 percent, from 1: 8.71 to 1: 8.28 against the USD. Then, after the outbreak of the Asian financial crisis, as the Thai Baht and the Korean Won experienced huge depreciations, China refused to devalue the RMB, resulting in a stable 1: 8.28 from 1997 to 2005. We still believed in the benefits of the exchange rate reform and that a managed floating currency is the right exchange rate mechanism for China, but the existence of inertia or path dependencemade reform very difficult. Then, on July 21, 2005, the reform started again and we had three years of fluctuations up until 2008. During this period, the RMB was in fact subject to two-way fluctuations and followed the direction of the currency basket. But in 2008, a series of events occurred, including the outbreak of the sub-prime mortgage crisis.Soon thereafter Bear Stearns went under, and Lehman Brothers declared bankruptcy on September 15, 2008, pushing the financial crisis to a climax. From then on, the RMB remained near the level of RMB 6.83 against the USD, with minor fluctuations, until June 19 of this year, when we again launched the RMB exchange rate reform. Looking back on history, it is clear that we have never lost sight of this mechanism; we were just interrupted by the outbreak of the crisis and other factors. Nevertheless, this is the best choice for China, a choice that we should uphold. Hu: What is the ultimate goal? Yi: Our ultimate goal is to make the RMB a convertible currency. This is the goal that was made in the fall of 1993, at the Third Plenary Session of the 14th CPC Central Committee. Hu: What is the relationship between a convertible RMB and its exchange rate? Is its free convertibility based on free floating? Or is the RMB freely convertible under a managed floating exchange rate mechanism? Yi: This question can be very theoretical. Usually a convertible currency has a freely floating exchange rate. At the Bretton Woods Conference, it was agreed that the major currencies would be pegged to the U.S. dollar, which in turn was pegged to gold at US$35 per ounce. This in fact was a fixed exchange rate system. But when the Bretton Woods system collapsed in the 1970s, the peg to gold was abandoned along with the fixed exchange rate system. In theory, convertible currencies should have a floating exchange rate because the mechanism for a floating exchange rate can act as a stabilizer for the convertible currency. In other words, the float ensures its convertibility. If the USD is always pegged to gold, it is impossible to achieve convertibility between the two. In contrast, if the USD is floating, sustainable convertibility can be achieved. Another extreme example lies in the Currency Board system practiced in Hong Kong and other regions. It is a special arrangement that gives the Currency Board no power to effect monetary policy. It can only be implemented in a small and fully open economy, and should be considered an exception that proves the rule. Generally, a convertible currency should have a very flexible exchange rate mechanism. A relatively developed country, or a mature emerging economy, should eventually choose to exercise monetary policies independently and to ensure the free flow of capital. To do so, it has to eliminate the fixed exchange rate. That is the case in the U.S. and in the Euro Zone, where the USD and the Euro are allowed to fluctuate widely according to the market situation. Hu: When can the RMB become convertible? Is there a timetable? Yi: We dont have an official timetable for RMB convertibility in China. But according to an IMF study, for an average country, it takes about 7 to 10 years to transition to capital account convertibility from current account convertibility, which China achieved in 1996. Now, 15 years later, China still hasnt achieved capital account convertibility, and we do not have a timetable. People can make their own judgments based on international practices. The main reason is China is too big and our development is too uneven, which makes the problem very complicated and it is difficult to achieve a consensus. Hu: In terms of currency appreciation, we all know that there are both external pressures and domestic needs. Comprehensively, what are the reasons that the RMB still cannot have a floating exchange rate? Yi: What really makes a currencys exchange rate float is the real effective exchange rate, which can be altered in two ways. The first is to adjust the nominal exchange rate, and the other is to increase domestic prices. In face of appreciation pressures, we do not have to adjust the nominal exchange rate because inflation can change the real effective exchange rate. Both methods have been used by China in the past decade, with adjustments in both the nominal exchange rates and prices. The surge in the housing prices is a good example. Hu: Now after several rounds of exchange rate reform, peoples expectations of a RMB appreciation should be pretty low now. Do we still need to continue the adjustment via inflation? Yi: It is safe to say that the pressure has weakened. In the recent decade, housing prices have gone through the roof in Beijing and Shanghai. In fact, commodity prices as a whole have greatly increased. These price hikes are actually adjustments against imbalances. Ten years ago, if you converted USD into RMB and bought property in China, you could make a lot of money, but now it is no longer a very lucrative deal. The same is true for other assets. All these indicate that, compared with ten years ago, the RMB exchange rate is now much closer to an equilibrium level. Now, the exchange rate is not likely to fluctuate sharply and we are in a position to maintain a flexible exchange rate regime and to keep the exchange rate stable at a reasonable level of equilibrium. Every coin has two sides. The constant increase in labor productivity in China has determined the overall trend in currency value. Under such a trend, appreciation can curb inflation; a bit more appreciation would mean a bit less inflation. So if the nominal exchange rate remains the same, the result will be more inflation. Some might argue that the Chinese people do not need imported goods, so a RMB appreciation will result in no benefits. This is wrong. Take soya beans as an example. Over half of the soya beans consumed in China are imported, and bean products are in high demand. Even soya bean pulp is needed to breed pigs, which means soya beans are somehow related to pork prices. If the RMB does not appreciate, then the prices of soya beans, bean oil, and bean pulp will be at least 20 percent higher than they are now. At present, these soya products are becoming very expensive on the international market, but the price increase is not that apparent in China. Why? Because the RMB has gone up and soya prices are mostly calculated in USD. It is the same for crude oil and iron ore, which, believe it or not, are also closely related to every household. So a currency appreciation can control imported inflation. In addition, many Chinese people travel abroad or send their children to study overseas. They are also the beneficiaries, but they are the silent majority.The small number of people who do not gain from the RMB appreciation mainly work in the export industry. They are the ones who complain loudly that they will lose their jobs and their lives will become miserable. Before the exchange rate reform in 2005, the relevant department made an that the cost was RMB 8.11 for state-owned enterprises and RMB 8.07 for private enterprises. If the cost is higher than the exchange rate, then the enterprises will suffer losses. If that were the case, when the RMB exchange rate jumped to RMB 8.11 on the first day of the launch of the foreign exchange reform in 2005, export enterprises would have had massive losses. But during the period from 2005 to 2008 since the reform, Chinas exports have been growing at an annual rate of over 20 percent. In other words, the adjustment of the foreign exchange rate did not hurt exports; on the contrary, during these years, exports witnessed substantial growth, along with industrial upgrading, technological progress, product upgrading, and the increase of added value of Chinese products. So we should view this question dynamically. The government is trying all methods to formulate sound policies and to create an enabling environment. For example, instruments for hedging and forward settlement and sales of foreign exchange are offered to help import and export enterprises to hedge against risks. Another misconception is that a RMB appreciation means losses in our foreign exchange reserves. In 2007, when the RMB was appreciating very rapidly, some observers said that the loss of foreign exchange reserves in one quarter would be worth one aircraft carrier. Now, we have 2.45 trillion USD in foreign exchange reserves (equivalent to more than RMB 16 trillion). With the RMB going up, the foreign exchange reserves, in RMB terms, would appear to be less in number, but that does not mean the money is gone. We would suffer some losses if we were to convert the foreign exchange reserves from USD to RMB, but we havent converted yet, so there is no such loss. Such a calculation is conversion on book value only. If such a calculation has to be done, we might as well do the math by calculating how much we will have earned if all RMB assets are put into USD. Take the financial and housing assets in China as an example; the total value of those assets would be RMB 200 trillion (over ten times that of the foreign exchange reserves). If the RMB appreciates and these assets are marked in USD, we can gain at least ten aircraft carriers. But of course, the truth is we neither gain nor lose. Hu: Thats right. They did not take into account the RMB assets. In addition, Chinese peoples savings can increase in value as well. Yi: Right, so we have to look at the issue comprehensively. Right now, we have neither gained nor lost anything. It is the different reporting currencies that are creating the different impressions. Of course, inflation in the U.S. can lead to weakened purchasing power of Chinas foreign exchange reserves. That can be considered a loss, but over the years, the rate of return of foreign exchange reserves has always been higher than the rate of inflation in the U.S. Hu: The abnormality of the foreign exchange rate would exert pressures on resources and the environment. Can you elaborate on that? Yi: If the nominal exchange rate is distorted, there would be a series of consequences. The foreign exchange rate is a price, and its distortion would definitely lead to the distortion of resource allocations. We have always emphasized the importance of expanding domestic demand. If the foreign exchange rate is distorted, foreign demand would be more lucrative, and enterprises would not try to expand domestic demand. Therefore, the distortion of the foreign exchange rate hinders the expansion of consumption and growth of the services industry. Hu: In face of the inflationary pressures, it is suggested that we should increase the interest rate, but can it replace the leverage of the foreign exchange rate? Yi: The interest rate represents the price of capital, whereas the foreign exchange rate is the ratio of the price of one currency against other currencies. These two are interchangeable in very limited ways, and there is always the question of how far away they are from the point of equilibrium. This can trigger endless arguments, because no one knows exactly where the point of equilibrium is. In theory, it is determined by supply and demand. In the best-case scenario, both the interest rate and the foreign exchange rate are close to the point of equilibrium. If the interest rate is increased, the currency will be stronger. Recently, many currencies have increased interest rates, but the USD, the Euro, the Japanese Yen, and the Pound have not. Foreign exchange rates and interest rates have different roles to play, so it is better that they fulfill their respective functions. Hu: The long-term fixed exchange rate has caused a certain degree of distortion. Now the exchange rate is being changed to a floating rate. At present, aside from the mind-set problem, the greatest threat perhaps comes from speculative attacks? Yi: Yes. So, we should continue to decrease these risks. As the market plays a greater role, it will be less lucrative to speculate on the foreign exchange rate. By then, people will give up speculation. Hu: The foreign exchange reform has been interrupted repeatedly. Is the progress a bit too slow? Yi: China is a big developing country. In the past three decades, China has created an economic miracle in the history of mankind. In this sense, Chinas macroeconomic policies have changed track. There might be some criticism concerning the degree of marketization or the delay of reform, but from 1994 to the present, China has maintained a high growth rate. In addition, since the 1994 inflation, so far we have not experienced another big inflation. On the whole, Chinas macro-economic policies are almost optimal. Indeed, we have been interrupted many times, and some might even think that the foreign exchange reform is not occurring fast enough. This question is open to discussion and reflection, but it is fair to say that our macro policies are generally successful. Hu: Why did the government choose the present time to recover the elasticity of the foreign exchange rate? Is it because it is less risky now, or because there are greater external pressures? Yi: China has made this decision mainly based on domestic considerations. It is an independent decision. Like I said, during the global financial crisis, the exchange rate was stable for a while. In fact, the crisis is not yet completely over, as is evidenced by the European sovereign debt crisis this year, but the overall picture is much better than before. As the crisis is receding, our growth rate increased last year from 8.7 percent to 9.1 percent. For the U.S., Europe, and Japan, 2010 is also widely predicted to be a year of recovery. Given the domestic and international background, I think now is the ripe time to recover the elasticity. Hu: But how do we evaluate the role of the foreign exchange rate reform in the external imbalance? Yi: Foreign scholars use their own framework to analyze the issue, and they believe that the foreign exchange rate is an important factor for rebalancing. In fact, as history has shown, the foreign exchange rate is indeed important, but it is not a decisive variable, which is very clear if you look back at the history of Japan and Germany. The appreciation of the Japanese Yen and the German Mark in the 1970s and 1980s did not lead to the immediate disappearance of the trade surplus in Japan or Germany. This might be true in China as well. But this question is very tricky because of a reverse question: If Chinas trade surplus cannot be adjusted even when the RMB appreciates, then is appreciation all good and no bad? Think about it, if the RMB appreciates, I can buy foreign goods very cheap; and if even then, my trade surplus cannot be cut, I have all the benefits, right? This is a tricky question. How to become a rule-maker? Hu: Can China become a rule maker? Yi: This is a huge question. We have always stressed the importance of taking part in the making of international rules. Who makes the rules for the so-called international monetary system? Apparently, major developed countries, especially the U.S. Then how did the U.S. become a rule maker? It was because the US dollar market is open, and it is the main theater for the global financial market. Naturally, whether for stocks or bonds, the rules shall be made by the authorities in charge of those markets, i.e., the U.S. and Europe. We are not yet a rule-maker, but as long as we open up the market and allow foreign players access to our turf, the Chinese monetary and regulatory authorities will then have every right to make our own rules. That is for sure. Hu: I recently interviewed Russia's first Deputy Prime Minister Igor Shuvalov. He said that sooner or later the RMB will become a reserve currency, whereas the Russian ruble will at most be a regional currency. What do you think? Yi: We cannot be too complacent. It will do us harm. China is still a developing country. We should bear in mind our limits. Hu: Then is it possible for the RMB to become a reserve currency? Does the world need it? Yi: This compliment is half flattery, half prediction. We should be modest and prudent, and keep a low profile. If the RMB is chosen by other countries to be a reserve currency, we will let it happen, because it is market demand. But we are not going to push it. I think the best way is to let things run their own course. We must not take the flattery too seriously; in fact, the RMB is still far from being a reserve currency. Hu: Are reserve currencies chosen naturally by the market? Or do we need governments to decide which should become a reserve currency? Or is it a bit of both? Yi: For a currency to become a reserve currency, the first most important factor is the economic strength of that country or confederation; the second is its cultural cohesion and influence; and the third is political and military power. Economic strength is the deciding factor. As to culture, it is important to have an influential culture, whose core values will be widely accepted by other countries and regions. A reserve currency must be backed by a powerful culture and influential value system. Do not underestimate the resilience of the US and Europe Hu: Two years ago, in the midst of the financial crisis, many people, including some Chinese, underestimated the USD and overestimated Euro. Now, the outbreak of the recent European debt crisis seems to prove that Europe cannot be overestimated either. In the past, investors ignored the problems of the U.S.; now, they have gone from one extreme to another. Yi: Let me just talk about Chinas foreign exchange reserve investments. We have always insisted upon the diversification of our foreign exchange reserves, on the two levels of currencies and assets. In terms of currencies, we diversify our investments across all major currencies, such as the USD, the Euro, the Japanese Yen, the Pound, and the currencies of the emerging economies. For each currency, we have to decide whether to buy bonds or other assets in order to achieve asset diversification. Back to your question, in fact, we have not underestimated the USD or the Euro. But the massive size of our reserves makes it impossible for adjustments to be made promptly. Diversification, as we have insisted upon, is in fact an asset allocation principle. Then how is the asset allocation principle determined? It is determined by Chinas real economy, to be specific, the proportion of trade, FDI, and account settlement in Chinas real economy. Hu: China seldom makes comments on specific investments of its foreign exchange reserves, but regarding the recent development of Fannie Mae and Freddie Mac, the authorities seem eager to make their attitudes known to the public. Why are Fannie Mae and Freddie Mac so important? Yi: They are important because of their vital role in Americas housing market and in the stability of the financial market. Shortly after the outbreak of the sub-prime mortgage crisis, the U.S. government still relied upon these two institutions to alleviate the crisis, but as the crisis deepened, these two organizations collapsed and were taken over by the U.S. government. Now the U.S. Treasury as their biggest shareholder owns about 80 percent of their shares. Recently, they were de-listed from the NYSE, but this does not constitute a negative impact on their securities. The recent announcements were made by the State Administration of Foreign Exchange to help the public understand that the foreign exchange reserve assets are safe and our management is effective. Hu: After the financial crisis, both Europe and the U.S. made some adjustments and changes. What do you think of their ability to recover? Yi: I think they have strong resilience and should not be underestimated. The U.S. financial regulatory reform bill, recently signed into law, marks another milestone after the Glass-Steagall Act of 1933, and the Financial Services Modernization Act of 1999 signed by former President Clinton represents a reflection of the past several decades, especially the recent round of the financial crisis. Aside from the U.S. bill, there is also a new roadmap for a financial regulatory framework drawn up by Britain, and a series of financial regulatory standards formulated by the Financial Stability Board under the G20, the IMF, the Basel Committee, and the Bank for International Settlements. All these have formed global financial regulatory standards and a framework for the coming decade or even longer. Under such a regulatory framework, their capacity to recover is relatively strong and the speed is relatively fast. Europe has made many contributions to the establishment of an international financial regulatory framework, but, of course, the U.S. is leading the way as it passed the regulatory reform bill. Hu: Recently, I interviewed Michael Evans, vice chairman of Goldman Sachs. He said that Goldman Sachs is prepared to adjust its strategy. In fact, Wall Street is still resistant to the U.S. financial regulatory reform bill, but Goldman Sachs will adjust its position and embrace the reform. It has set up the Business Standards Committee, which, after investigation and research, has come up with concrete measures to change its business behavior. When talking about the lawsuit against the U.S. Securities and Exchange Commission, he said that although the case has a political bias, we must admit that we made mistakes too. Judging from his attitude, there is a possibility of mediation, but he emphasized that mediation does not mean the end, and Goldman Sachs still needs to adjust its business behavior. But from another perspective, since the financial reform bill has been spoken so highly of, why is it so difficult to implement? Why is the Republican Party so vigorously opposed to the bill? Yi: The difficulties stem from conflicts of interests. The bill used to contain clauses that harm the interests of investment banks and commercial banks, but they have been watered down now and compromises have been made. On the whole, I think this bill is positive, and the prompt adoption of this bill is so much better than no action at all. Uncertainty would accumulate if no measure were taken. Now the launch of the bill ends the suspense, stabilizes market expectations, and can restore the market to normalcy. Be Realistic about Chinas Economic Growth Hu: I have a question about the macro economy. Do you think there is a big chance of a Double Dipin the world economy? Yi: The short answer to this question, as far as I see it, is no. But a precise explanation depends on the definition of Double Dip. This year, the U.S. economic growth rate hopefully will be 2.5 percent to 3.5 percent. In Japan, the growth rate will be above zero, probably even above 2 percent; as to Europe, possibly 0.5 percent to 1.5 percent. No one would call this a Double Dip,but there are still many uncertainties, considering the worrying situation in the U.S. housing and job markets. Hu: Chinas economic growth rate was 11.1 percent for the first half of 2010. Will it drop in the future? Yi: For the whole year, the growth rate could reach 9 percent, which is fairly high already. Perhaps we are a bit too obsessed about high growth rates. I hope to see a more moderate approach, which can help extend the long-term growth of the Chinese economy. China has now become the second largest economy in the world. As our economic base expands, growth rates will definitely slow down. In addition, the environmental constraints have reached a bottleneck, with a host of problems concerning underground water, air, and carbon emissions. There are also resource restrictions, including the import of energy. Based on the above reasons and the general rules of economic development, there is no doubt that there will be a slowdown in our economic growth. In the three decades after the launch of the reform and opening up, Chinas average GDP growth rate exceeded 9.5 percent. In the first decade of the new century, the rate was over 10 percent. For the second decade, I would say an average growth rate of 7 percent to 8 percent is good enough. The question is whether we can sustain such a growth rate. If in the third decade, we manage to grow at 5 percent to 6 percent, then we would have had 50 years of rapid growth, an unprecedented feat in human history. In fact, the problem of Chinas economy lies in the quality of its growth. That is why we have been restructuring and transforming patterns of growth; we are trying to improve the quality and effects of economic growth. We should adjust our mind-set; being too impatient doesnt help. 2010-07-30/en/2010/0730/943.html