UPDATE 1-China FX reserves top $1.43 trln, may be understated

BEIJING, Oct 12 (Reuters) - China’s foreign exchange reserves, the world’s largest, swelled to $1.434 trillion in the third quarter, and analysts said the figure could have been higher but for the country’s new sovereign wealth fund.

The reserves grew by $101 billion in the three months to the end of September, less than the $130 billion surge in the second quarter, the People’s Bank of China said on Friday.

The central bank did not say how much of the reserves, if any, had been used to capitalise the sovereign wealth fund, China Investment Corp (CIC), recently established to manage part of the stockpile in search of higher returns.

“It is possible that China’s FX reserves in September are understated,” said Mingchun Sun, an economist at Lehman Brothers in Hong Kong.

CIC’s funding will come from the Ministry of Finance, which will issue 1.5 trillion yuan ($200 billion) in special bonds to buy foreign exchange from the central bank.

So far about half of those bonds have been sold to the market, but it is not known whether the central bank has transferred foreign exchange to CIC yet.

“Our judgement is that this accounting switch from official foreign exchange reserves to assets on the CIC’s balance sheet was minimal in the third quarter, but could be more significant in the fourth quarter,” Sun said in a note to clients.

Accumulation of currency reserves could also have been tempered by government policies to encourage Chinese banks, companies and individuals to invest more capital abroad.

“The low figure might be because of the transfer to the foreign exchange investment agency, capital outflows under the Qualified Domestic Institutional Investor (QDII) programmes and Chinese bank ventures overseas,” said Gene Ma at China Economic Monitor in Beijing.

Economists said the growing stash would generate more pressure for the yuan to appreciate and strengthened the case for the government to permit more capital outflows.

China’s reserves rose by $367.3 billion in the first nine months of the year. For all of 2006, they rose by $247.3 billion.

The reserves have more than tripled in the past three years, rising $209 billion in 2005, $207 billion in 2004 and $117 billion in 2003.

The reserves have ballooned because the central bank, in order to hold down the yuan, buys most of the dollars generated by a growing trade surplus, foreign direct investment and periodic inflows of speculative capital.

The policy is a major irritant in relations with the United States and the European Union and is sure to be on the agenda of next week’s Group of Seven finance ministers’ meeting in Washington.