Kontent Review

BEIJING -- China should push yuan reforms, let firms hold more

foreign currency, and raise gold reserves to help slow the rise in

foreign exchange reserves, an influential government economist said.

China should ideally hold about $700 billion in foreign exchange

reserves to ensure debt repayment, finance imports and maintain

stability, Xia Bin, head of the financial research institute at the

cabinet's Development Research Centre, said in a research report

seen by Reuters on Monday.

The rapid rise in China's reserves, the world's largest at $853.6

billion at the end of February, had made it hard for the central

bank to control money supply and showed that China had failed to to

keep badly needed capital at home, Xia said.

A spokesman at the State Administration of Foreign Exchange which

manages the reserves, declined to comment on the report.

The reserves have soared in recent years as the People's Bank of

China, trying to hold down the yuan, has bought most of the dollars

generated by a growing trade surplus and the inflow of foreign

direct investment and speculative capital.

Investing those dollars, China has become a big buyer of U.S.

government bonds and other dollar assets, helping to finance a heavy

U.S. current account deficit and to keep U.S. interest rates low.

"We cannot underestimate the possible loss to the reserves if, in

the long run, the United States adopts a weak-dollar policy and we

are still maintaining a high level of dollar reserves."

China is keen to hedge risk by diversifying its reserve holdings

away from the dollar, but economists say that fears of a collapse in

the U.S. currency will prevent any dramatic shift.

Xia suggested the government should consider a combination of

measures to slow down the build-up of China's foreign exchange

reserves, including giving the yuan more leeway to move.

The government should also consider allowing firms to hoard more

foreign currency and establish an investment fund to channel hard

currency and personal investments overseas, Xia said.

The central bank might need to raise its gold reserves, which had

been too low in recent years, to reflect China's status as a major

trading nation, he said.

Part of the forex reserves could be used to recapitalise state banks

following the injection of $60 billion into China Construction Bank

Corp., Bank of China, and Industrial and Commercial Bank of China,

Xia said.

"How to effectively ease the upward pressure is vital for the yuan

exchange rate reforms and also vital in resolving the problem of the

runaway growth in foreign exchange reserves," Xia said.

China must follow its own independent policy, regardless of foreign

pressure, by letting market forces adjust the yuan's value towards

its "equilibrium level", he said.

The authorities should keep the yuan's crawling appreciation

and "appropriately widen its floating band," Xia said.

In July China revalued the yuan by 2.1 percent against the dollar

and shifted to a managed float. The yuan has appreciated a further

1.3 percent versus the dollar since then and the pace of rises has

quickened in recent weeks, ahead of President Hu Jintao's visit to

the United States.