March 10, 2017 9:50 pm JST

China central bank chief shrugs off foreign reserves decline

More unified regulations to rein in shadowy wealth-management products

JOYCE HO, Nikkei staff writer

Zhou Xiaochuan, governor of the People's Bank of China. (Photo by Akira Kodaka)

BEIJING -- Zhou Xiaochuan, China's central bank governor, told reporters on Friday that the sharp depletion of China's foreign reserves is not worrying, but a natural phenomenon.

His remarks came after the People's Bank of China reported on Tuesday that its foreign exchange reserves had broken an eight month declining trend and grew in February to reach $3.005 trillion, thanks to a slew of capital control measures including curbing outbound investments.

"In fact [the foreign reserve] doesn't have to be that huge," Zhou said at a briefing at the country's legislative National People's Congress in Beijing, which runs alongside the Chinese People's Political Consultative Conference.

"It's partly boosted by hot money," said Zhou, who noted that at least a third of the $4.2 trillion in financial flows created by aggressive quantitative easing in developed economies following the global financial crisis had entered China in recent years. Such flows, said Zhou, tended to move out again as developed economies recovered. He noted similar phenomena in emerging economies such as Russia, Brazil, South Africa and India.

"There are problems to solve. But we don't have to cast them in such a grave light. Don't overreact," said Zhou. "It's normal for the foreign reserve to decline."

Zhou said the stockpile, close to $4 trillion at its peak in 2014, had built up rapidly since 2002 in the aftermath of the Asian financial crisis. "Reserves are meant to be spent at the right time, but not hoarded," said Zhou. "We don't really want so much in the first place. It's not a bad thing for it to dip."

David Dollar, senior fellow at the John L Thorton China Center at Washington-based think tank the Brookings Institution, said China has drained its foreign reserve on purpose and the trend could continue for a couple of years without derailing the economy.

"Excessive stockpile"

"$4 trillion was unnecessarily large," Dollar told the Nikkei Asian Review. "As they introduce more flexibility into the currency, they do not need such a large stockpile of reserve."

"As they sell reserves and Chinese firms and households invest abroad, they are basically taking resources that China already invested abroad in U.S. treasury bonds. And they are letting households essentially take over those resources and shift them into stock investments and real estate investments," said Dollar. "I think that's a smart strategy."

"I think they will succeed in managing that capital outflow in 2017," he added. "China has pretty effective capital control."

Zhou said the yuan's volatility in the second half of last year was driven by a cocktail of factors, including accelerated outbound investments and the strength of the greenback.

"There are a lot of surprises after Donald Trump won the presidential election last year. That caused the U.S. dollar index to spike, and hence the [yuan's] volatility," said Zhou, adding that a certain level of foreign exchange volatility is normal.

Since September 2015, in the run-up to the yuan's inclusion in the International Monetary Fund's special drawing right a year later, the yuan has been fixed daily against a trade-weighted basket of currencies. The U.S. dollar weighting has been slashed to 22.4% from 26.4% since the beginning of the year when the number of currencies in the basket increased to 24 from 13.

US rate rise no threat

Zhou also appears to see no threats from the impending rise in U.S. interest rates. "Japan's interest rate has been subdued for so many years, which apparently has a huge differential with other money markets. But that does not necessarily lead to obvious, persistent speculative activities or capital flows," said Zhao, who suggested China's interest rate in the medium term will be determined by its economic growth, employment, inflation and public confidence.

Zhou said the yuan will return to a more predictable trajectory as China's economy stabilizes and the results of supply-side reforms materialize, giving more confidence to the international community in China. He added that the PBoC will maintain a similar stance on forex policy this year, while being more precise in its effort to regulate the market. Monetary policy will also be "prudent" and "neutral."

Aside from promoting fintech and financial inclusion in rural areas, a key task of the PBoC this year, according to Zhao, will be to collaborate with other financial regulators to rein in China's wealth management products, which had grown to a total of 100 trillion yuan by the end of last year.

Fraught with arbitrages and speculative activities, the rather "unruly" wealth management market, said Zhou, was made more problematic by the lack of unified product standards and a weak rapport between various financial regulators.

Some asset management or wealth management products exist to facilitate arbitrage or illicit purposes and trap money in the financial system, said Zhou. "We emphasized that asset management and other financial businesses are meant to serve the real economy. Money going from one hand to the other does not really go into the real economy."

He said the PBoC, the State Administration of Foreign Exchange and the three financial regulators overseeing the banking, insurance and securities sectors, will work more closely together to bring regulations in line. "The cooperative mechanism has been developed primarily two years ago," said Zhao. "We have consensus on a lot of bigger issues."

"After more revision, we will push forward some preliminary regulations," said Zhao.

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