Monday, November 21, 2011

Awkward questions about China's reserves

WHOSE money is it anyway?

That question, referring to China's huge foreign exchange reserves, has been the subject of much recent debate here following news that Beijing's help was being sought to beef up a rescue fund for tottering European economies.

As the world's largest holder of forex reserves, China is under international pressure to join a bailout of Europe, which hopes to double the fund to €1 trillion (S$1.75 trillion).

China's top officials have so far remained non-committal on whether they will go to Europe's aid, but that has not stopped a burgeoning debate at home centred on the country's US$3.4 trillion (S$4.4 trillion) worth of forex reserves.

The issues raised have evolved beyond relatively straightforward economic considerations of investment risks and returns, or how Chinese exports will gain from throwing a lifeline to the Europe Union, whose countries make up China's biggest trading partner.

Instead, the heated discussions among netizens and in the Chinese media have taken an increasingly political tone. Some have called for aid to be linked to conditions that give China more say on the global stage. Others question why China should help developed countries when the money could be better spent on struggling businesses or the poor at home.

At the heart of this clamour is a fundamental question that Beijing is hard-pressed to answer: To whom do China's forex reserves really belong, and whose interests should they serve?

In theory, this is a no-brainer: The money does not belong to the people. 'Forex reserves are the central bank's money and represent the country's wealth, (they are) not to be understood as the common expression of the Chinese people's 'blood and sweat money',' asserted a People's Daily editorial a month ago.

The Communist Party newspaper, which broadly reflects the government's views, said it was a misconception that forex reserves are what millions of Chinese enterprises and workers get in exchange for their toil.

Instead, it explained, the reserves rightfully belong to the central bank, which 'purchased' them from exporters by issuing yuan for the foreign currency they get in trade.

China has a controlled exchange rate and closed capital account, so Chinese businesses and people can hold only limited amounts of foreign currency.

And since the Chinese people cannot participate in currency speculation, the authorities have to do it on their behalf, the People's Daily added.

Such arguments drew derisive responses from scholars such as Geneva-based Chinese economist Xiang Lanxin.

'Despite the convoluted technical jargon employed by the central bank apologists, the logic of their argument appears crystal clear to ordinary citizens: The forex reserves are none of your business, but earning them is your duty!' he wrote in the South China Morning Post.

He further questioned if the reserves were serving the interests of corrupt officials: 'Are there kickbacks involved for purchasing foreign bonds?'

'Jiang Yong, a leading Chinese government analyst of financial securities, revealed recently he had been told that the dirty side of foreign exchange operations was much bigger than in the railway sector,' Mr Xiang added. Billions of yuan are believed to have been lost through corruption in China's huge rail projects.

While such claims are hard to prove, it is widely acknowledged that China's cash-pile is not transparently managed by the State Administration of Foreign Exchange (Safe) and the China Investment Corporation. These agencies are ranked among the world's most secretive government agencies that manage sovereign wealth.

So closely does China guard its information that it does not even subscribe to a set of specific disclosure standards for macroeconomic data that 65 countries, including much poorer states such as India and the Kyrgyz Republic, adhere to. Instead, Beijing has opted for a more general standard that is meant for International Monetary Fund (IMF) members with less developed statistical systems.

Given the opacity and its size as the world's No. 2 biggest economy, it is little wonder that China has reportedly met with resistance to its demands in exchange for helping Europe.

Beijing is said to have wanted a bigger say in decision-making in the IMF and to have a European Union arms embargo lifted. It is also said to have asked for market economy status - which would make it harder for other countries to start trade proceedings against it.

Reports of such conditions are likely to please the 24,000 readers polled by the state-linked newspaper Global Times recently. The respondents not only supported these strings attached, but they also had one more: Stop interfering in China's domestic affairs.

What is becoming clear is that China's huge forex reserves are becoming a matter of public interest, and Beijing is not immune to public pressures.

With rising social discontent and anger at official corruption and mismanagement, it is perhaps unsurprising that Safe put up a list of 16 frequently asked questions (FAQ) some months back to address criticisms that China's reserves were undiversified, losing value and fuelling inflation at home.

In a sense, Beijing is trapped. It refuses to acknowledge that it should provide greater accountability in its handling of the reserves and yet it is facing growing populist pressure on what to do with all that money.

This raises the hazard that political consideration might creep into play in the management of the funds.

Certainly, it is not easy to institute a system that ensures the reserves best serve national interests alone. But for starters, China could be more forthcoming with its figures and sign up to international standards such as the IMF's specific disclosure rules.

With tighter rules on accountability in place, officials deliberating future risky investment decisions would be forced to practise what Safe itself pledged in its July 28 FAQ: More information disclosure and transparency to 'safeguard the security and interests of China's foreign exchange reserves'.