China’s foreign exchange reserves exceed $2 trillion

China’s foreign-exchange reserves, the world’s biggest, topped $2 trillion for the first time as the nation’s economic recovery prompted overseas investors to pump money into stocks and property.

The reserves rose a record $178 billion in the second quarter to $2.132 trillion, the People’s Bank of China said today on its Web site. That dwarfs a $7.7 billion gain in the previous three months.

The Shanghai Composite Index, the world’s second-best performer, surged 75 percent this year as Premier Wen Jiabao’s stimulus package triggered record lending and surging investment. The increase in the reserves means China may buy more U.S. Treasuries as the Obama administration sells record amounts of debt to fund its own plan for reviving growth.

“Hot money is flowing back,” said Sherman Chan, an economist with Moody’s in Sydney. “China has the strongest prospects out of all major economies.”

M2, the broadest measure of money supply, rose a record 28.5 percent in June from a year earlier, the central bank said.

The yuan traded at 6.8316 against the dollar as of 4:47 p.m. in Shanghai, from 6.8329 yesterday.

The central bank has used bill sales to push up money- market rates for three weeks, seeking to tighten monetary policy without choking off a recovery as the surge in money supply increases the risk of asset bubbles, bad loans and resurgent inflation. China’s reserves are double those of Japan, the country with the second-biggest foreign currency holdings.

‘Great Challenges’

“The pace of foreign-exchange inflows will accelerate in coming months as China’s recovery attracts investors, and that will pose great challenges for monetary policy,” said Lu Zhengwei, an economist at Industrial Bank Co. in Shanghai.

The trade surplus was $34.8 billion in the second quarter and foreign direct investment was $21.2 billion, leaving the bulk of the increase in the reserves unaccounted for. Investment returns and currency movements also affect their size.

Dariusz Kowalczyk, chief investment strategist at SJS Markets Ltd. in Hong Kong, saw speculative capital and higher valuations for non-dollar assets as the biggest factors. Ben Simpfendorfer, an economist with Royal Bank of Scotland in Hong Kong, said speculative capital may have accounted for $50 billion of the increase and gains by the euro for $35 billion.

“The capital inflows have driven up stock and property prices,” said Yang Shengkun, a currency analyst in Beijing at China Citic Bank Co. “Speculators are favoring China because the government’s stimulus package is working quite well, which will help the country to be the first to recover globally.”

Easing Capital Curbs

China’s foreign currency regulator said today it will ease curbs on outflows of capital. The State Administration of Foreign Exchange will expand the sources of capital Chinese can use to fund outbound spending and let companies send investment funds overseas without prior approval, it said in a statement on its Web site today.

“The rules are intended to give companies more room to develop overseas and reduce their pain” in adjusting growth models, Liu Guangxi, an inspector at SAFE’s capital-account department, said at a press briefing in Beijing. “The changes will help China to realize a more balanced management of both capital inflows and outflows.”

China should “moderately” increase its holdings of U.S. Treasuries and purchases this year should not be lower than the total for 2008, a People’s Bank of China economist wrote in the China Securities Journal today.

Wen’s Worries

The holdings can be trimmed and purchases of other types of U.S. assets stepped up once the American economy recovers from a recession, Wang Yong, a professor at the central bank’s Zhengzhou-based training school, wrote in an article in the Xinhua News Agency-affiliated newspaper.

Central bank Governor Zhou Xiaochuan ruled out any sudden change in the management of the reserves last month after proposing that governments investigate setting up a supranational currency. Premier Wen Jiabao said in March that he was “worried” about the safety of the nation’s U.S. assets. China holds $763.5 billion of Treasuries.

“It’s inevitable that China will continue investing in Treasuries because of the sheer scale of its reserves,” said Ken Peng, an economist with Citigroup Inc. in Beijing. “Diversification will happen at a slow pace, with commodities the favored alternative.”

About 65 percent of China’s reserves are in dollar assets, with the rest mostly in euros, yen and sterling, estimates Wang Tao, an economist with UBS AG in Beijing. It is “difficult to stop buying U.S. Treasuries when markets for most other assets are too small and too illiquid,” she said in a report last month.

China’s economic growth rebounded to 7.8 percent in the second quarter, according to a Bloomberg News survey of economists. That number will be released tomorrow.

Source: Bloomberg

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