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China must factor hot money into policy move -adviser

BOAO, China (Reuters) - China should bear hot money in mind when setting policy as a recent surge in its foreign exchange reserves implies that footloose global capital is still pouring into the country, a central bank adviser said on Sunday.

An employee counts Renminbi banknotes at a bank in Nanjing, Jiangsu province April 10, 2008. REUTERS/Sean Yong

China’s reserves, the world’s largest, rose by $153.9 billion in the first quarter, dwarfing last year’s quarterly average of $115 billion; less than half of the increase could be explained by China’s trade surplus and foreign direct investment inflows.

“Although many institutions in Western countries are hoarding liquidity due to the credit crunch, some capital is in fact still not affected, such as petrodollars,” Fang Gang, an adviser to the People’s Bank of China (PBOC), said in an interview.

The central bank buys most of the dollars coming into China in order to hold down the yuan’s exchange rate. In doing so, it injects yuan into the banking system, making it hard to control the money supply and providing fuel for inflation.

“Investors are seeking investment opportunities, but obviously they’re not going for the time being to Western countries that are seriously hit by the credit crunch. They’ll turn to emerging markets such as China and India,” said Fan, who holds the academic seat on the PBOC’s monetary policy committee.

Stressing that he was speaking in a personal capacity, Fan said he expected more money to flow into China as the dollar is trending down and the United States is cutting rates while China is moving on the opposite direction.

China has let the yuan rise faster this year to help fight soaring inflation. The currency strengthened 4.2 percent in the first quarter alone and about 16 percent in all since it was revalued by 2.1 percent in July 2005.

Investment returns plus the yuan’s appreciation can offer foreign investors an annual return of as much as 20 percent, Fan said on the sidelines of the Boao Forum for Asia being held on the southern Chinese island of Hainan.

And individuals can transfer small sums of money from Hong Kong to the mainland, which can also cumulatively have a non-negligible impact on liquidity, he added.

“So in this sense, excess liquidity is likely to remain in China. Policy makers should bear this in mind and not rely on any one policy tool to address it,” Fan said.

He drew the distinction with many Western central banks that rely predominantly on interest rates.


Fan said that the this year’s quickening rise in the yuan is mainly due to a sharp decline in the dollar.

“So as for where the yuan would be in balance, you shouldn’t just ask the Chinese. You should ask the United States when the dollar will be stabilised,” he argued.

Fan said the U.S. subprime crisis made China more determined to follow a gradualist approach to market liberalisation.

“Drastic reform is not the answer as such for a low-level developing country because it often lead to ups and downs and a lot of pain,” Fan said.

Beijing can not pursue financial reform at the expense of economic growth and employment, he added.

“Slow job creation would lead to serious problems in the future and lost export orders from foreign clients might not come back ever.”

He told critics to think twice before lecturing China to carry out a one-off liberalisation of its foreign exchange regime, interest rates and capital controls.

“Looking at the ongoing U.S. subprime crisis, shouldn’t we all become more cautious about the financial risks? In steering our reforms, should we follow the philosophy that has given birth to the credit crisis?” he asked.