Financial thoughts

China's foreign-exchange reserves, the world's largest, surged to $1.68 trillion at the end of March, adding pressure on the government to prevent money inflows from fueling inflation already at an 11-year high.

Currency holdings expanded 40 percent from a year earlier, the People's Bank of China said today on its Web site. The assets grew a record $153.9 billion from the end of December, after a $94.6 billion increase in the fourth quarter.

Exports, foreign investment and U.S. dollar depreciation have boosted China's currency assets, hampering government efforts to rein in money supply and inflation. China last month ordered lenders to set aside more deposits as reserves for a second time this year and has let the yuan rise at a quicker pace to stem cash inflows.

“The rapid accumulation in foreign-exchange reserves is making it very difficult for China to control money supply and inflation,'' said Wang Qing, chief China economist at Morgan Stanley in Hong Kong.

Consumer prices surged 8.7 percent in February from a year earlier, the most since May 1996, after the worst snowstorms in half a century disrupted food supplies. Chinese policy makers including Premier Wen Jiabao have named inflation and overheating as China's biggest economic risks this year.

The yuan closed at 7.0065 versus the dollar in Shanghai from 6.9995 before the data was released.

Country-Sized Increase

The increase in currency reserves is more than the annual economic output of some countries, such as New Zealand.

China's economy, the world's fourth largest, expanded 11.9 percent in 2007 from a year earlier, the fastest pace in 13 years. A strengthening Chinese currency, up 4.3 percent already this year against the dollar, has encouraged inflows of speculative capital. The yuan gained 7 percent in 2007.

“The pace of hot money coming into China has picked up, exacerbating the accumulation of foreign reserves,'' said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong. “The government will slow the appreciation of the yuan to ease speculation.''

To tame liquidity, the central bank has pushed the required reserve ratio for lenders to a record 15.5 percent. China has held off raising interest rates after six increases last year as the U.S. Federal Reserve cuts borrowing costs.

Trade-Surplus Cash

“Raising interest rates will only attract more money into China,'' said Morgan Stanley's Wang, who expects faster yuan gains to rein in a trade surplus that pumped $41.4 billion into the financial system in the first quarter.

A stronger currency makes exports more expensive. Tighter control of foreign-exchange inflows, higher reserve requirements and more bill sales to soak up cash are also likely, according to Wang.

The central bank today cited slower money-supply growth as evidence that its “tight'' monetary policy is having an effect. M2, the broadest measure, grew 16.3 percent in March from a year earlier, the slowest pace since January 2007.

A falling dollar contributes to the build-up of China's foreign reserves as the assets are quoted in the U.S. currency, according to UBS AG economist Jonathan Anderson.

“The onset of the credit crisis and the crumbling of the U.S. housing bubble precipitated a significant sell-off of the dollar,'' said Anderson, who is based in Hong Kong. That has boosted the value of the assets that China holds in other currencies.

“A sizable portion, 35 percent to 40 percent of China's foreign-exchange reserves, is held in European and Japanese assets,'' he said.

Growing reserves prompted the government to set up an investment arm last year to increase returns. China Investment Corp., a $200 billion fund, bought stakes in Blackstone Group LP, the New York-based private equity firm, and Morgan Stanley.

Sourse