China’s management of its foreign exchange (forex) reserves is expected to shift steadily toward a "new normal" state, and a decline in reserves may be seen in the coming years.
For decades China used its forex reserves mainly for financial investment in order to avoid a decline in their overall value, but now there are signs that it is using the reserves to back up its external policy strategy.
News portal cankaoxiaoxi.com reported on May 5 that according to official US data, China’s holdings of US securities assets stood at $1.817 trillion as of June 2014, accounting for just 46 percent of China’s forex reserves at that time, down from 69 percent in June 2009.
As the dollar weakened following the 2008-09 global financial crisis, it dragged down returns from US securities assets, and an increasing number of voices called for China to trim its holdings to avoid a contraction in value.
But this is only part of the story.
The weaker dollar did not dampen global enthusiasm for US securities. According to media reports, Japan, which has traditionally held a relatively conservative attitude toward management of forex reserves, overtook China in February 2015 as the top foreign holder of US Treasury securities for the first time in years.
According to the latest data, China in March raised its US Treasuries holding for the first time in the past seven months and moved back to being the top foreign holder of US Treasury securities, but this does not conflict with the conclusion that China has begun to innovate and diversify the use of its huge forex reserves.
Over the past year, China has cut its US Treasuries holdings by $49.2 billion.
Media reports have said that the China Development Bank (CDB) and the Export-Import Bank of China (EXIM), two of China’s State-owned policy banks, will receive a capital injection totaling $62 billion that will be drawn from forex reserves.
Following the capital injection, the two policy banks will have greater ability to support China’s outbound direct investment and the "One Belt, One Road" initiative.
The "One Belt, One Road" strategy, which refers to the Silk Road Economic Belt and the 21st Century Maritime Silk Road, was proposed by President Xi Jinping in late 2013.
The country also set up a $40 billion Silk Road Fund and initiated the Asian Infrastructure Investment Bank (AIIB) to back up the strategy by offering financing assistance.
The Silk Road Fund, which was launched in December 2014, was contributed to by different sources and some of China’s forex reserves were put toward it.
These new measures show that China has changed its approach to using forex reserves. US securities assets are expected to remain one of the main investment channels for China’s forex reserves for a long period yet, but the country may further trim its US Treasury holdings in the coming years and use forex reserves to increase expenditure in supporting its external policy strategy.
Guan Tao, head of the international payments department at the State Administration of Foreign Exchange (SAFE), confirmed at a press conference late in April that his administration would continue to broaden investment channels in terms of the use of forex reserves.
Guan also said China would back up its national strategy using foreign exchange reserves while aiming to increase revenue from investment of the reserves at the same time.
According to official data, China’s foreign exchange reserves dropped to $3.73 trillion in March, marking the seventh consecutive month of decline.
It is normal to see a decline in forex reserves given that China has reported a slowdown in net forex inflows, with the capital and financial accounts having registered a deficit since the second quarter of 2014.
As China has further opened up its capital account and accelerated outbound investment under the "One Belt, One Road" initiative, the deficit in the capital and financial accounts expanded to $30.5 billion in the fourth quarter of 2014.
The growth in the deficit and decline of forex reserves, accompanying the shift in the management of reserves, will contribute to a rebalancing of the Chinese and global economy.
The Wall Street Journal reported on May 3 that IMF is close to declaring China’s yuan fairly valued for the first time in more than a decade. Such a reassessment of the yuan could be officially announced in the IMF’s upcoming report on China’s economy.
