‘PBOC engineering caps China FX reserves

BEIJING: China has artificially held down the accumulation of foreign currency reserves on the books of the central bank by guiding state-owned banks to buy overseas bonds, investment bank Goldman Sachs says.

To shield the banks from currency risk at a time of a rising yuan, the People’s Bank of China (PBOC) may have arranged a total of $40-50 billion in currency swaps with Bank of China, China Construction Bank Corp and Industrial and Commercial Bank of China at an implied yuan appreciation rate of 2-3 percent a year, the bank said. Goldman’s research is the latest attempt by PBOC-watchers to explain an apparent paradox: given China’s current account surplus last year of about $230-250 billion and foreign direct investment inflows of $63 billion, why did the PBOC’s official reserves rise in 2006 by only $247 billion?

Part of the discrepancy might be due to unannounced use of the central bank’s reserves. Last month, Beijing disclosed that it had pumped $4 billion into the country’s biggest reinsurer. But Goldman economists Hong Liang and Eva Yi, drawing on flow of funds data for the banking system, said the answer lay principally in an increase of $70 billion in foreign exchange assets held by Chinese commercial banks.

That was twice as much as the rise in 2005 and took banks’ FX position to about $190 billion, or 15 percent of the banking system’s total FX position the rest is held by the PBOC. Balance of payments data for the first half of 2006 show banks ploughed most of the foreign currency into bonds.

Secret swaps: Liang and Yi said it was hard to argue that banks chose to buy FX bonds on commercial grounds because they have limited FX operations and, since August 2006 when the yuan’s pace of climb started to quicken, the trade has been losing money. Furthermore, the banks’ decision to add aggressively to their FX assets contrasts with a steady drop in Chinese households’ holdings of FX assets. Just this week, Bank of China said it had closed one of the first funds through which retail investors could buy overseas bonds because of heavy redemptions. reuters

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