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ECONOMY-CHINA: Trillion Dollar Investment Blues

Antoaneta Bezlova

BEIJING, Apr 13 2007 (IPS) - As China’s foreign exchange reserves continue their explosive growth, questions about the ways the country’s financial mandarins manage its pool of wealth are growing both inside and outside China.

While Beijing wants safety and long-term stability of its investments, Chinese leaders face domestic pressures to utilise its hoard of foreign currency to further the country’s economic and strategic interests, even if it means diversifying the holdings into more risky, but higher-yielding investments.

Reserves topped 1.2 trillion US dollars by the end of last month, confirming China’s status as the world’s biggest holder of foreign exchange reserves. What is more, they continue to climb by more than 20 billion dollars a month on the back of China’s ever growing trade surplus.

How China decides to use its newly acquired wealth has ramifications for financial and commodities markets worldwide as was evident by last year’s jump in the price of gold following reports that China was preparing to buy huge quantities of it.

In the past, Beijing has tapped its massive reserves to recapitalise the country’s biggest domestic financial institutions, pumping some 60 billion dollars into three of China’s four big government-controlled banks.

While foreign exchange reserves have rapidly grown over the past five years Chinese government officials feel the country now has enough financial resources to counter potential external shocks and can be more daring in investing its funds.

In March, the government announced its decision to entrust some 200 to 300 billion dollars of reserves in the hands of a new, yet unnamed investment agency. Analysts suggest that if given enough authority the new investment body could deploy hundreds of billions of dollars to acquire financial or strategic assets around the world, particularly in the developing countries of Africa and Latin America.

Long conservative about its external investments, China is perceived as a rather cautious money manager that would put its bets on safety rather than profitability. The country’s top leaders have at least suggested that much.

Chinese Premier Wen Jiabao has said the goal of the new agency will be to “preserve and increase” the value of China’s foreign exchange holdings and suggested it would take a conservative approach.

“China’s diversification of its foreign exchange reserves is based on considerations of the safety of that foreign-exchange,” Wen said at the close of the annual session of China’s legislature in March.

Wen’s remarks were directed at those predicting that China’s plans for global investment might upend the international financial order.

Most of China’s currency reserves are invested in U.S. dollar-denominated debt, such as U.S. treasuries, earning a low but steady return. Some in Washington and world markets fear that China might decide to suddenly dump its dollar holdings, setting off a tidal wave of sales and imperiling the U.S. economy.

But while sounding calm on the country’s investment moves, Chinese leaders face domestic concerns that the reserves, believed to be invested for the bigger part in those low-risk, low-return U.S. treasuries, are not used more productively to deliver benefits for China.

“China is a big developing country with a huge population but inadequate resources,” says Liu Yuhui, an expert at the Finance Research Institute under the Chinese Academy of Social Sciences. “Acquiring oil fields, mines and even arable land could all become viable channels for investing the available funds to help sustain the country’s development.”

This is an argument heard not only among the academics but China’s top officials as well. Last December, the official press agency Xinhua quoted Chinese deputy prime minister Zeng Peiyan as saying that part of the Chinese foreign currency reserves will be used to buy vital resources like coal, iron and oil.

Others have suggested that the money should serve “patriotic purposes” by furthering the interests of China’s state-owned companies abroad. A report in the Shanghai Securities News proposed utilising some of the funds to make strategic investments for national energy enterprises like China National Offshore Oil Corp. or acquiring foreign technology to enhance China’s modernisation.

However, many are aware that such strategy could provide ammunition for more accusations about the nature of “China Inc”. In 2005 China’s failed attempt to buy U.S. oil company Unocal caused a protectionist backlash, with some in the U.S. Congress suggesting Beijing was financing its aggressive shopping spree with funds acquired in the process of keeping the home currency undervalued.

Guo Tianyong, a banking expert at the China Central Finance and Economics University, says only the establishment of a specialised investment agency can ward off such and other dangers in the future.

“What we face now is that the slightest rumour about China’s intended purchase of commodities can drive up prices instantaneously. Without a proper investment vehicle that would operate in conditions of commercial secrecy, we can easily be at disadvantage and pay higher prices,” he said.

Many officials have hinted that Beijing’s new investment vehicle would mirror Temasek Holdings, the Singapore government’s investment arm which manages a huge portfolio of government funds.

Guo Tianyong however, suggests China is unlikely to allow markets total freedom in deciding the best potential investments. “If the new investment agency behaves totally like a market enterprise it cannot fully realise its potential to deliver benefits to the people,” he argues. “Sooner or later, as shown with Temasek, there would be a clash of interests. This is what we, in China, would like to try and avoid.”

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