My Blog

November 29, 2007

THU 29 NOV 2007

Reserves at $1.455 trillion

Growth in reserves continues to astonish.  Yesterday the NDRC announced that reserves had hit $1.455 trillion by the end of October.  This means they were up $21 billion for the month of October, after rising by $136 billion in the first quarter, $130 billion in the second quarter, and $101 billion in the third quarter, for a total of $388 billion year to date.  This compares with a huge $247 billion for all of 2006, and an already very high $209 billion for 2005 and $207 billion for 2004 (the $117 billion increase in reserves in 2003, a big number then, now seems almost insignificant).

 

We know that the trade surplus for the month was a record $27.1 billion, and FDI inflows were $6.8 billion, which implies that net other flows were a negative $13 billion, but it is hard to figure out how to think about that number.  There may have been an additional transfer to the CIC, and it seems that banks and SOEs (and even retail investors) are being encouraged to hold dollars offshore themselves.  The total amount of money that came into China in October through the current and capital accounts, in other words, is a lot higher than $21 billion and is probably even a lot higher than $34 billion (because of hot money inflows), but its impact on the PBoC’s balance sheet has been reduced by PBoC transfers to the CIC and by other capital account outflows.

 

The CIC can be though of as a sort of “second” central bank although dollars held by the CIC are not, strictly speaking, monetized in the same ways that dollars held by the PBoC are.  Because it was (or will be) fully funded by an RMB-denominated bond issue, the money creation associated with CIC holdings are fully “sterilized”, and they are sterilized by the issuance of long term MoF bonds, not central bank bills.  These MoF bonds still have an expansionary monetary impact, but clearly they are much less money-like than central bank bills, and the effective substitution in the market of these MoF bonds for PBoC bills (the PBoC has indirectly purchased the bonds but plans to use them as part of its open market operations) will reduce money creation somewhat.

 

If other entities are holding more dollars, this is also good for China because the domestic monetary impact of the foreign currency inflows into China is limited, but we should be careful not to assume that in this case the monetary impact is zero.  For example, if banks are holding more of their reserves in dollars, the PBoC has clearly been spared the problem of buying those dollars and so monetizing them, but at the same time those dollar holdings may free up RMB holdings in the banks that can now be used for loan purposes. 

 

In that case I think the positive monetary impact (i.e. the fact that the PBoC did not have to create currency or bills to buy them) might be negligible – foreign currency inflows are still likely to cause an effective increase in domestic money.  In general for any company or individual, and not just for the banks, if holding dollars abroad becomes a substitute for holding RMB investments domestically, I would guess that the monetary impact of dollar inflows is still positive and may be substantial.  They do not necessarily need to show up on the PBoC’s books for them to affect domestic monetary conditions.  I wonder if any of my readers might have any better insight and chime in here.

 

I don’t know if there is still a lot to transfer from the PBoC to the CIC before the end of the year (altogether $200 billion were to be transferred this year, and I am guessing that at least one-third was already done), but even if there is, total reserve growth at the PBoC plus the CIC will easily exceed $500 billion this year and may even exceed $600 billion.  At 17-20% of GDP, this level of reserve growth cannot help but be a serious problem for domestic monetary policy.