China spends US$195 billion to maintain currency peg
Channel News Asia
BEIJING : China's central bank spent 1.61 trillion yuan (195 billion dollars) buying foreign currency last year to maintain the yuan's peg with the dollar, a rise of 40 percent over 2003.
The People's Bank of China also drained 669 billion yuan from the banking system via open market operations last year, more than double the 282 billion yuan used in 2003, Xinhua news agency said citing a central bank report.
"The central bank faces comparatively large pressure in the management of money flow and currency control," it said.
China keeps its currency pegged to the US unit in a very narrow trading bank of about 8.28 yuan, a level which trading partners, especially the United States, say gives Chinese exports an unfair advantage.
The government is not only under political pressure to let its currency appreciate but the central bank is struggling to mop up the extra cash in the system flowing in on speculative bets that it will free up the peg.
China has resisted foreign pressure to loosen the yuan peg but has promised that it will move over time towards a more flexible exchange rate regime.
Balloning trade surpluses and years of foreign investment have flooded the financial system with cash and market players say the central bank has been virtually the only buyer of surplus hard currency such as the dollar.
As a result, China's foreign reserves in 2004 soared to a record 609.9 billion dollars from 403.3 billion dollars in 2003, with the increase equal to the total intervention amount.
Meanwhile, China's 60 billion dollar current account surplus, up 25 billion dollars from 2003, and 61 billion dollars of foreign direct investment (FDI), were additional large sources of foreign exchange, ING economist Tim Condon said in a note.
This still leaves 74 billion dollars (614 billion yuan) of non-FDI capital flows, coincidentally roughly the same amount as the central bank drained from the system through its open market operations.
"This is the monetary management issue that we believe will motivate the authorities to reform their exchange rate regime by introducing greater two-way risk some time in the second quarter of 2005," Condon said.
In attempt to ease pressure on the currency, China will cut its growing balance of payments surplus by permitting more foreign currency to leave the country, state media reported earlier this week. – AFP
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Prudent Investor says
While the going gets good...China has been able to finance its currency peg with its large surpluses, plump foreign reserves and 'turning on the crank'...until when?
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