China seeks new ways to spend US$ 1 trillion

China seeks new ways to spend US$ 1 trillion

By Zhou Jiangong, Jan 23, 2007
http://www.atimes.com/atimes/China_Business/IA23Cb04.html

SHANGHAI - China has finally decided to diversify disposal of its huge yet steadily growing foreign-exchange reserve by investing in overseas markets, a dramatic departure from its current practice of putting most of its eggs into one basket - US Treasury bonds.

The decision was made at the all-important Central Conference on Financial Affairs, which ended on Saturday.

A state-owned company will be set up to invest the Asian powerhouse's US$1 trillion foreign-exchange reserve in overseas markets.

In his keynote speech to the conference, Premier Wen Jiabao said the government "will strengthen the management of foreign-exchange reserves and actively explore, and broaden, channels and manners for making use of the reserves".

The conference, the third in the past decade and a half, has been proclaimed by Wen as the "turning point" for the country's financial industry.

Most economists and analysts in China have agreed that the country now has too much foreign reserve. They argue that the appropriate amount - a figure that would not cause internal and external imbalances - could be set at about $700 billion. That means China now has an excess of $300 billion that could be used for overseas investment.

China currently puts most of its foreign reserves in US dollar assets, particularly in US Treasury bonds. In this way, when the Chinese currency steadily revalues against the greenback, the foreign reserve is "shrinking" on the book when converted into yuan. The yuan has gained more than 5% against the dollar since July 2005, which means the loss in book value could be up to $50 billion.

Diversifying investment would help reduce the risks involved in managing the huge foreign reserve.

Informed sources say that the new company handling foreign-reserve investment will be derived from the Central Huijin Investment Co. As the investment arm of the central government, Huijin has made its name by injecting reserves of tens of billions of dollars into state-owned banks and other financial institutions.

Huijin holds shares in the Industrial and Commercial Bank of China (ICBC), Bank of China (BOC) and China Construction Bank (CCB). It also controls the country's biggest securities brokerages and indirectly controls the biggest mutual funds. Huijin has just announced that it will inject $4 billion in China Reinsurance Group, giving it a 92% controlling stake, while the Ministry of Finance takes the remaining 8%.

The high-profile conference only decided in principle to diversify foreign-reserve investment. Before China actually invests its foreign reserves overseas, operational rules to implement the policy are expected to be worked out by relevant government departments.

The conference delegates also tried to settle a turf war between ministries over which one would oversee individual financial sectors. Top financial regulators currently include the People's Bank of China (PBoC), China Banking Regulatory Commission (CBRC), China Insurance Regulatory Commission (CIRC), and China Securities Regulatory Commission (CSRC). Thus when a bank is allowed to operate insurance and securities brokerage businesses, it is under the supervision of the four regulators.

While discussion on the proposal of setting up a super-body overseeing the operation of banking, insurance and securities brokerages was shelved at the conference, the State Council has pledged to "strengthen the mechanisms of supervision and coordination" in the financial industry.

Competition for the control of state financial assets between the PBoC and the Ministry of Finance (MOF) has also been well known among China's decision-makers and financial officials.

At this conference, it appears that the MOF's efforts to dominate the supervision and management of state financial assets has been thwarted. Another powerful department, the National Development and Reform Commission (NDRC), is also losing its control over financial affairs. Both have financial divisions employing dozens of bureaucrats, compared with hundreds of counterparts in the four financial regulators, a lot of whom are sophisticated bankers and financial experts with degrees from prestigious universities in the United States and Europe.

For a while NDRC, PBoC and CSRC have competed for the job of supervising the issuance of enterprise bonds. The conference has made it clear that the CSRC continues to be the one overseeing the issuance of enterprise bonds for financing the state enterprises and infrastructure projects. Meanwhile, CSRC has also taken the mandate of approving the issuance of corporate

bonds, China Business News, a leading business newspaper based in Shanghai, reported.

The conference also indicated that China's economic development and reform will focus on the financial industry in the near future. The government has realized that sustained growth will largely depend on the modernization and opening up of the country's financial markets.

Wen said that China's financial sector is at a "turning point" and that reform of the sector is entering a new era. With the end on December 11 of the five-year transitional period for its entry to the World Trade Organization (WTO), China has fully opened its banking sector to foreign investors and further relaxed its restrictions on overseas investment in the insurance and securities industries.

Although the factor is not mentioned in official statements, the major banks have been required to "deepen" reform to cope with new challenges created by the opening up of the sector, to strengthen the competitiveness of the country's financial institutions in the face of increasingly aggressive competition from their foreign rivals.

Zhou Xiaochuan, the governor of PBoC, said the successful listing of three of the big four state lenders, ICBC, BOC and CCB, is "preliminary" and the next stage of financial reforms will be "complicated, hard, and time-consuming".

The State Council has decided to restructure the Agricultural Bank of China (ABC), the last of the big four lenders, into a joint-stock enterprise and "seek opportunity for public listing". For this purpose, the government will have to inject huge amounts of capital into ABC to boost is capital adequacy and lower its non-performing-loan ratio.

The State Council also decided to restructure the China Development Bank (CDB), the country's policy bank. It is also widely expected that CDB will be injected with billions of dollars in order to enable it to finance China's "going out" strategy.

The messages from the conference sent a strong signal to the stock market in Shanghai and Shenzhen: the government is determined to broaden and deepen capital market reforms in coming years. The Shanghai A-share index shot up to 3,070 at 2:30pm on Monday, up 96 points or 3.21% from last Friday.

It appears that the conference has served as a venue for handling important policy changes.

The first such conference was held shortly after the Asian financial crisis in 1997. It was during that meeting that Chinese leaders made the decision not to devalue the yuan despite the sharp decline of nearly all other Asian currencies. It was also during that meeting that the decision was made for the Ministry of Finance to bail out the technically insolvent big four lenders by injecting billions of yuan and stripping off hundreds of billions of yuan in bad debts.

The second Central Conference on Financial Affairs was held in 2002, after China joined the WTO, with a focus on how to strengthen supervision on commercial banks and how to prevent a financial crisis from sweeping the country. The 2002 meeting decided to kick off a restructuring of ICBC, BOC and CCB, with an aim to turn them into joint-stock enterprises for public listing. For this purpose, the Chinese government once again had to inject funds, $60 billion in total, into the three lenders. The CCB is now listed in Hong Kong while the other two sell stocks in both the Hong Kong and Shanghai bourses. After the conference's decision, the China Banking Regulatory Commission (CBRC) was set up to enhance the supervision of commercial banks.

China's pledge to deepen financial reform at the third financial conference has been welcomed by overseas financial institutions registered in the country. "The conference, which was held at the end of the grace period for China's WTO accession, was of great significance for the nation to constitute an open, competitive financial regime," David Dollar, director of the World Bank office in Beijing, told Xinhua.

Tang Min, chief economist with the Asia Development Bank Mission in China, said: "The strategies and principles set out at the conference will further crystallize the future orientation of China's financial reform. The financial sector, as an economic engine, should also make a readjustment as China continues its shift from solely stressing economic growth to building a harmonious society."

Zhou Jiangong is a Shanghai-based analyst on China's political, economic affairs and international relations.

Related link: http://www.atimes.com/atimes/China_Business/IA23Cb04.html