MNI: PBOC Off'l Says FX Stash Needed For Stability, Not Profit

--Says PBOC Strategy Safeguards Country's Assets

     BEIJING (MNI) - The primary purpose in managing China's foreign-exchange

reserves is to stabilize the currency's exchange rate and dampen capital outflow

risks, with profiting from the reserves a secondary focus, according to a senior

official at the People's Bank of China.

     Sheng Songcheng, a PBOC counselor and former director of its Survey and

Statistics Department, said at a closed-door speech in Beijing on Tuesday that

"security and liquidity" are the main aims of the PBOC. "The primary goal ... is

not to think about profitability," Sheng said. 

     The earning power of China's $3 trillion-plus forex pile has come under

recent debate, with some analysts and officials arguing that the PBOC should

diversify away from its preference for low-yield U.S. government bonds. 

     How the PBOC actually manages the largest forex stash in the world is a

closely guarded secret, and the regulator has never released any public

information on its management strategy. According to China International Capital

Corporation (CICC), a state-owned investment bank, U.S. dollar-denominated

assets accounted for 66.7% of the forex reserves portfolio in 2016, which is

slightly higher than the 63.6% of U.S. dollar-denominated bonds held as a

percentage of global forex reserves.

     The yield on the 10-year U.S. government bond currently stands at 2.32%,

compared with the 3.985% of its counterpart in China.

     Huang Qifan, vice chairman of the Financial and Economic Affairs Committee

of the National People's Congress, said last week during the Caixin Summit in

Beijing that the central bank's forex reserve management strategy was

unproductive, as it focused on low-risk liquid assets such as treasury bills.

Huang also said the PBOC's forex management had led to a number of financial

problems, including excessive money supply and asset bubbles, and had thus

"hijacked" the central bank's monetary policy. 

     According to Sheng, though, Huang's view "is a huge misunderstanding of

China's basic currency structure and monetary policies."

     Sheng argued that the central bank had made the decision to invest mainly

in U.S. government bonds in order to safeguard the country's assets and maintain

a strategic hold over management of the economy. Money supply, Sheng stressed,

serves the central bank's monetary policy and occurs as a result of economic

stability and development. 

     "The system of money creation has changed in China as the forex purchase

position has continued to decrease in recent years, which has restricted the

growth of money supply," Sheng said. "Therefore, the PBOC relies on money-market

instruments, including open-market operations, the Standing Lending Facility,

and the Medium-term Lending Facility" to guarantee money supply. 

     The foreign-exchange purchase position of the PBOC edged up slightly in

October for the second straight month to CNY22.22 trillion, but that was after

22 consecutive months of declines. 

     In the balance sheet of the PBOC, the item of "Claims on Other Financial

Corporations," which gauges lending from the central bank to financial

institutions, increased to 27.2% of total PBOC assets in October, compared with

4.4% in the June 2014, when forex reserves hit a peak of $3.99 trillion. This

indicates that the PBOC has tended toward a reliance on money-market instruments

to inject liquidity into the interbank market. 

     Sheng attributed China's huge forex reserves to the need for maintaining

stability of the yuan, which he said has resulted in China playing a bigger role

in world trade. 

     China has now become the biggest trading country in the world, in part

because it has strictly controlled appreciation of the yuan since it entered

into the World Trade Organization in 2001, Sheng said. "The persistent purchase

of forex has been for the stabilization of the yuan exchange rate," Sheng

reiterated.

     Huang, meanwhile, has argued that the Chinese government should entrust the

Ministry of Finance to manage forex reserves, instead of the PBOC, in order to

get higher returns on the locked-up wealth. "The Ministry of Finance could issue

government bonds and entrust organizations including CICC to make investments

with the forex reserves, which would make over a trillion yuan in annual

income," Huang said.

     But Sheng countered this argument by saying "the PBOC had allowed the

Ministry of Finance to issue CNY1.55 trillion in Special Government bonds in a

bid to buy $200 billion worth of forex reserves in 2007. The ministry later

invested in CICC" -- an investment strategy that did not prove to be successful.

     "It increased the government debt ... and even could have triggered

inflation, so it was not a proper way to manage forex reserves," Sheng argued.

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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