April 12, 2007 / 10:36 AM / 12 years ago

UPDATE 2-China's foreign reserves breach $1.2 trillion

(Adds details, background)

By Eadie Chen and Zhou Xin

BEIJING, April 12 (Reuters) - China’s foreign exchange reserves breached $1.2 trillion in the first quarter after a record quarterly jump, but money supply growth eased slightly in March in response to a government tightening campaign.

The central bank said on Thursday that reserves had swollen by $135.7 billion to $1.202 trillion between January and March, more than half the $247.3 billion reserves accumulation for the whole of 2006.

Analysts said the quarterly jump, which will have intensified upward pressure on the yuan CNY=CFXS, had confounded expectations, given a narrowing in the country's trade surplus in the first three months.

“It is a bit strange because there was a huge gap between the FX reserve increase and the size of the trade balance in the first quarter,” said Jun Ma, an economist for Deutsche Bank in Hong Kong.

“Implication-wise, it certainly continues to put pressure on the currency despite the significant drop in the trade balance in March.”

The record quarterly rise in reserves followed increases of $78.4 billion in the fourth quarter, $46.8 billion in the third and $66 billion in the April-June period of last year.

The reserves grew by $44.7 bln in March and $52.7 bln in February, the central bank said in a statement on its Web site (www.pbc.gov.cn).

China’s reserves have ballooned in recent years as the central bank, in order to hold down the yuan, has bought most of the dollars generated by a growing trade surplus, inflows of foreign direct investment and speculative capital.

China’s trade surplus narrowed to $46.44 billion in the first quarter, compared to $67.75 billion in the final three months of 2006.

Some economists speculated that the jump in reserves may have been driven by central bank moves to wind down swap agreements with commercial lenders.

The People’s Bank of China has been quietly entering swap agreements with commercial banks to keep dollars off its books so that it has less yuan to mop up, or sterilise, from the banking system.

Others guessed hot money inflows spurred by bets on a dearer yuan may have played a role. Those flows had grown to $73.3 billion in the first quarter after retreating in the second half of last year, JPMorgan’s Qian Wang said in a note to clients.

MORE TIGHTENING

Such inflows have flooded the banking system with cash, helping to fuel an investment binge and making it more difficult to rein in money growth.

The central bank has been trying to do just that by raising interest rates three times and raising the amount that lenders have to hold back in reserve six times in the past year.

Annual growth in the broad M2 measure of money supply slowed in March to 17.3 percent from 17.8 percent in February, the central bank said.

Annual loan growth also eased to an annual 15.7 percent in March, down from 16.6 percent in February.

“Loan grow in the first quarter accelerated, but money supply (levels) are basically appropriate and the financial market is stable,” the central bank said.

“The current pace of money supply growth is basically in line with the economy’s expansion.”

The excess reserve ratio for Chinese financial institutions fell to 2.87 percent at the end of March, down 0.11 percentage point on the year and 0.62 percentage point lower than the end of February, it said.

Still, China would probably need to take more tightening steps in the months ahead, economists said.

“Going forward, we believe commercial banks’ undamaged capability and incentives in expanding their lending may lead to renewed acceleration in money and credit growth in the coming months,” Hong Liang, an economist with Goldman Sachs, wrote in a research note.

“We expect the monetary authority to maintain the tightening bias and possibly intensify its efforts in window guidance if loan provision growth steps up again.” (Additional reporting by Jason Subler, Tamora Vidaillet and Langi Chiang)

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