Addressing Forex Conundrum
It is reported that Chinese policymakers are mulling reforms to allow individuals in Wenzhou, a hotbed of private economy in east China's Zhejiang Province, to directly invest in overseas assets.
The move is expected to loosen control over private investors, and widen their channel to invest abroad. More importantly, it is intended to diversify foreign exchange (forex) holdings of the country and facilitate a significant private wealth boom.
In the past 30 years, China has accumulated a pile of forex reserves thanks to torrid economic growth. Its forex reserves currently stand at around $3.2 trillion, accounting for more than 30 percent of the world's total, and three times that of Japan. As part of China's national wealth, the forex reserves have deep implications for the country's economic globalization.
But unlike most other nations, the official forex reserves accounted for a majority of China's overall forex wealth. For instance, the official forex reserve of the United States is only 20 percent that of China, but the forex holdings of private American investors are as much as $9 trillion. The official forex reserve of Japan is only more than $1 trillion, but its private holdings are at least $3 trillion.
China's International Investment Position showed that foreign direct investment (FDI) accounted for nearly 60 percent of the country's international liabilities, compared with only 55 percent for the United States. Foreign investors have made handsome profits from their investments in China. Moreover, the massive FDI inflows drove up China's forex reserves, but the country has parked most of the forex reserves in low-yielding U.S. Treasury securities.
That means China has yet to make full use of the forex reserves and produce tangible benefits to the economy and domestic residents. Between 1990 and 2008, China accumulated $60.553 billion of deficits in net investment return under the balance of payments.
In a bid to improve its asset quality and structure, China has a lot to learn from Japan. In 2005, Japan shifted its focus of national strategy from trade to investments, and increased efforts to raise returns on overseas investments. It also vowed to double the payment surplus-to-GDP ratio by 2030. In the last five years, Japan has harvested an annual average of $50 billion in interest on overseas securities, and its enterprises also generated enormous profits from their overseas portfolios.
For China, it is necessary to strike a balance between official forex reserves and private forex holdings, and diversify investments of forex reserves in a range of fluid and safe assets. Efforts are needed to kick-start a new round of reforms to optimize the structure of forex reserves.
First, China needs to build a multi-level forex trading market, and provide hedging tools for investors to reduce risks.
Second, the government should provide policy incentives to encourage private investors to go global. Meanwhile, it is necessary to accelerate internationalization of the renminbi, and facilitate overseas investments by individuals.
In addition, the country ought to establish funds to support entrepreneurs in overseas mergers and acquisitions, technology innovation and energy investments outside China.
This is an edited excerpt of views of Zhang Monan, an associate researcher with the State Information Center, published recently in the National Business Daily
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