China ponders what to do with its currency reserves

China's currency reserves, which rise by some $15 to 25 billion (11 - 18 billion euros) every month, hail from the country's export surplus. Although in 2009 this was smaller than in previous years, the reserves still grew by 20 percent - to a record $2.5 trillion.

900 billion are made up of US securities and between 65 and 75 percent of China's total foreign currency reserves are in US dollars. This is due in part to the fact that the US dollar has so-called "reserve currency status" but it also helps keep the external value of the yuan stable.

"A study says that the yuan has increased in value by about 20 percent since 1980 compared to the most important trading partners," explains Harwig Wild, an expert on emerging markets at Metzler Bank.

"In light of the huge growth of GDP and the production progress China has witnessed - with GDP growing at an average rate of 10 percent a year - this is just not enough."

China adversely affected by dollar crisis

So far, China has resisted pressure to appreciate the yuan, but it represents a risk for such a large proportion of the reserves to be in dollars. The People's Republic went through a tough time when the dollar sank in 2009 as a result of the financial and economic crisis.

That's why Beijing called for a new anchor currency and started accumulating euros in its reserves, which now make up an estimated quarter of the total. However, this strategy also turned out to have its down sides when the European debt crisis caused the euro to plummet and China’s currency reserves dramatically fell in value.

The State Administration of Foreign Exchange, a subdivision of the central bank, has insisted that it has faith in the European currency, but Beijing is nonetheless trying to diversify its reserves out of fear for the euro and the dollar.

Diversifying the reserves

The Chinese central bank is reported to have bought up Japanese securities en masse since the beginning of the year. Harwig Wild presumes China has also hoarded Australian and Canadian dollars, which Huang Zemin from the East China Normal University thinks makes perfect sense.

"One of the principles of currency reserves is to take currency risks into account," he explains. "That's why we also have to take strong currencies into the reserves. In the past few years, the price of the natural resources, which are abundant in Australia and Canada, has increased significantly. That’s why the two countries' currencies are called natural resource-based currencies."

There is also the option of directly investing "in natural resources, of all kinds," says Wild. "Apart from oil and gas, there is also steel and other metals and of course precious metals too. We can definitely assume that in future the Chinese Central Bank will invest more and more in raw materials and commodities at the expense of currency reserves."

Thus currency risks will be avoided. Moreover, this will also tally with the central government's geopolitical aims, as nothing is more important for China’s economy than a guaranteed supply of raw materials.

Author: Danhong Zhang/act
Editor: Thomas Baerthlein