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New market may shore up foreign assets

By Li Zhongmin (China Daily)
Updated: 2010-11-24 11:09

One of the primary tasks for the People's Bank of China (PBOC) is to deal with the problems brought on by inflation and asset bubbles since consumer prices rose 4.4 percent year-on-year in October.

The central bank will also have to deal with the mounting pressure brought on by worries over the influx of hot money.

By the end of 2009, China's foreign exchange reserves hit $2.45 trillion, 70.8 percent of the country's total foreign currency assets, which reached $3.46 trillion.

As is the case in China, Japan also has huge trade surpluses with a large accumulation of foreign currency assets. These surpluses are not putting pressure on Japan's monetary authority since Japan is keeping open its channels of outbound foreign investment. Its foreign exchange reserves account for a small portion of its total foreign currency assets.

Japan's foreign currency assets are largely held by the private sector. In China, however, a large portion of its foreign currency assets are held by the State in the form of foreign exchange reserves.

This is not what the PBOC wants to see. It's currently looking at other avenues of managing the massive foreign currency assets.

The best way is to develop a large-scale euro-dollar bonds market in China. The market should mainly trade US dollar-denominated fixed-income products, including foreign corporate bonds and Chinese corporate commercial papers.

Several fixed-income financial products in foreign currencies have already been circulated in China's market, including a US dollar-denominated, medium-term commercial paper issued by PetroChina and a seven-year US dollar-denominated bond issued by Goldman Sachs in China.

Developing a euro-dollar bonds market in China can bring more bonds business to China's financial institutions. Financial products such as corporate bonds and government debts used to be underwritten by financial institutions in the US. If these deals are transferred to China, China's financial institutions will create a large amount of underwriting businesses.

Developing a euro-dollar bonds market can also increase the income return of China's foreign currency assets with increased efficiency of investments and profit returns for holders of the bonds.

Such a market will bring a new financing channel at a low cost, which is helpful for China's overseas investments, especially for small- and medium-sized companies.

It will also help China build its own international financial center.

Although China has the basic condition for building a euro-dollar bonds market, it needs to make adjustments on some of its financial regulations.

First, China should reform its foreign currency reserves regulations. China's foreign reserves have gone beyond the needs for China to safeguard its international business security and stability. So a big portion of the reserves should go to the private sector.

Second, China needs to adjust its regulations on capital accounts. China should revise its regulations on foreign governments and companies issuing US dollar-denominated bonds in China. At the same time, China should study how to promote the successful experiences gained by certain Chinese companies on medium-term commercial paper issuing.

Third, China should set up a firewall between the euro-dollar bonds market and the international financial markets, preventing idle money to flood into China for higher returns. China should also set up a firewall between the potential euro-dollar bonds market and the yuan market.

The author is a researcher at the Chinese Academy of Social Sciences in Beijing.