If the growth of the economy of the Peoples’ Republic of China (PRC) at 10% of GDP per annum for over 20 years was specular, the accumulation of foreign exchange reserves (assets) was equally spectacular, perhaps more so. The reserve was $3.7 billion in January 1989 when the reforms to open its economy truly took off. It was reported to have risen to $3,119.7 bn. by April 2022. CEIC data reveal that the reserves rose steadily year-on-year and peaked in 2014 at $3,250 billion. Since then, they started declining due to economic slowdown, trade war with the US, pandemic, etc. Currently, China’s reserves are over $3 trillion. Other countries holding reserves are: Japan ($1.3 tn), Switzerland ($1.08 tn) and India ($597 bn).
There is a difference in the nature of accumulation of reserves between China and other countries, especially developing countries like India. While China’s reserves are built by acquiring the export earnings (dollars), some others acquire them through the process of sterilization of forex to maintain or safeguard the exchange rate for their currency. There is a rich crop of literature on “currency wars” and how China outwitted the US (Burial of a controversy: The IMF, the US and the Renminbi, Economic & Political Weekly, 5th September, 2009). The issue relevant for this column is the exchange rate policy adopted by the Peoples’ Bank of China (PBoC). For over 25 years, China maintained a stable rate for RMB at 8.28 for a dollar. China held economic stability as its core concern along with regional stability.
For instance, when the Asian financial crisis raged in 1997 and many countries depreciated their currencies, China held onto the rate and this policy softened the severity of the Asian crisis. It won plaudits for China as a responsible member. Stable rates and economic stability are said to be the triggers for FDI inflows. The country became the favoured destination for exporters. As exports galloped year after year, forex reserves surged. Indeed, there was a flip side. Many economists like Eswar S Prasad drew attention to the fact that the stable exchange rate tended to depress forex earnings, wages, etc. and the country was paying a heavy price.
In 2005, under pressure from domestic lobbies and external advisers like the IMF, China decided to change the exchange rate policy and make it market-determined.
The management of forex reserves and exchange rate for Yuan or RMB is entrusted with State Adminstration of Foreign Exchange. A respected player against heavy odds and turmoil in the global currency market, SAFE has managed well and has a good reputation on both accounts. SAFE has to ensure their safety and also get a reasonable return at a time when the rates gyrate.
The worries started when the reserves were becoming huge. It was then decided to adopt the ‘Go West’ policy of making investments in other countries to secure resources. China’s aid to Africa dates back to the Mao era in the 1950s. More importantly, Dr. Zhou Xiaochuan, the legendary Governor of the PBoC, announced a programme in March 2009 to internationalise the RMB. The idea was to reduce the monopoly of the dollar and to increase the use of RMB. The financial market was opened and Dim Sum bonds became the flavour of the Asian market.
Many central banks began to hold RMB in their reserves. The inclusion of RMB in the SDR basket was a crowning achievement. RMB is a legal tender insome countries. China has swaps with Asean countries. China knew that the dollar could not be replaced in the short run and was preparing for a long haul. OBOR or BRI is one of the most ambitious and strategic programmes that connect most continents. The idea is to use up the reserves for development. If the current atmosphere of Russian sanctions is extended to China, it would end all its dreams and turn inward and autarchic. It would also mark the end of the dollar hegemony that we witnessed in the post second world war years. It would also end the rules-based currency values and trading systems. In the currency market it may be the replay of the pre-war years when the gold standard collapsed.
To be fair to China, it was preparing for all the normal risks associated with the currency markets. It was always apprehensive of US’ measures. It wished to avoid too much reliance on dollar assets. In November 2019, CNBC disclosed some details of a report by ANZ Research Service. It showed that apart from reducing its holdings of US Treasuries, China was building “shadow reserves.” It was also reported to be on a gold buying spree with a stock of around 2,000 tonnes in October 2019. Leading advisers like Yu Yongding cautioned about the necessity to move reserves out of treasuries.
Experts gave several restructuring suggestions like turning inward, increasing consumer demand, etc. All this will take a long time and may not help in reducing or redeploying reserves quickly.
A meeting was held in Beijing by Chinese regulators with bankers to review the potential threat of sanctions against China. They wanted time to ponder. That is where the world stands. DAVOS meeting of this year was cheerless and indicative.
Served in the Ministry of Finance, GOI, and retired as Joint Secretary