Zhou Says $3 Trillion China Reserves Have Risen Beyond ‘Reasonable’ Level

China’s foreign-exchange reserves have exceeded a “reasonable” level and the management and diversification of the holdings should be improved, central bank Governor Zhou Xiaochuan said.

Increases in the holdings, which topped $3 trillion in March, are putting pressure on central-bank operations that withdraw money from the financial system, Zhou said after a speech atTsinghua University in Beijing late yesterday. Zhou spoke of the need to reduce an excessive accumulation of reserves, using a Chinese word that could refer to either existing holdings or the pace of the build-up.

The reserves climbed $197 billion in the first quarter, reflecting global imbalances that Group of 20 finance ministers agreed last week to address through deeper scrutiny of their economic policies. China’s surging holdings are fueling inflation that accelerated last month to the highest in 32 months, prompting the government to boost banks’ reserve requirements this week for the fourth time this year.

“Foreign-exchange reserves have exceeded the reasonable levels that we actually need,” Zhou said. “The rapid increase in reserves may have led to excessive liquidity and has exerted significant sterilization pressure. If the government doesn’t strike the right balance with its policies, the build-up could cause big risks,” he said, without elaborating.

Investment Inflows

Foreign direct investment into China jumped 33 percent to $12.5 billion last month from a year earlier, the commerce ministry said today. The world’s second-biggest economy grew 9.7 percent in the first quarter from a year earlier, faster than economists had forecast, and consumer prices climbed 5.4 percent in March, the government said last week.

The nation’s currency holdings jumped by the second-biggest amount on record in the January to March period, even as the nation reported its first quarterly trade deficit in seven years. Economists attributed much of the increase to capital inflows betting on appreciation of the yuan.

The funds have added to the liquidity that’s flooded the economy over the last two years as the government encouraged an unprecedented lending boom to support growth amid the global financial crisis.

Zhou said speculative inflows of funds are not a major concern given that China is a large economy which maintains controls on capital flows for investment purposes. Still, liquidity is excessive and the government needs to “remain vigilant” over the property market and take “counter- cyclical” measures to curb surging real-estate prices, he said.

Diversifying Investment

Diversifying the nation’s reserves through investment agencies such as China Investment Corp., the country’s sovereign wealth fund, is a consideration, Zhou said, while declining to answer questions on whether CIC will receive more capital from the nation’s foreign-exchange holdings.

CIC’s Chairman Lou Jiwei said the fund may get more capital to invest in overseas markets, China National Radio reported on April 17.

“One option is to consider some new types of investment agencies which focus on new investment areas,” Zhou said. “It’s inappropriate for me to detail the next stage of the plan, but the direction is clear.”

Fitch Ratings lowered its outlook on China’s AA- long-term local-currency rating to negative from stable last week, the first time in 12 years the nation’s debt rating faces a cut. Fitch said there was a “high likelihood of a significant deterioration” in banks’ asset quality after a record jump in lending in the last two years.

Moody’s Outlook

Moody’s Investors Service also lowered its outlook on China’s property industry to negative from stable on concern residential sales could decline by as much as 30 percent as local governments enforce housing curbs.

“The ratings given by international credit agencies shouldn’t be taken too seriously,” Zhou said. “They may have good insights on many projects and companies but it’s hard for me to comment on their sovereign ratings,” he said in response to questions about the revisions.

Loans to companies and households in China rose to about 140 percent of gross domestic product last year from 111 percent in 2008, Fitch said. Much of the increase was linked to property lending and credit to the financing vehicles of local governments who aren’t allowed to issue bonds.

Zhou said today that letting local authorities sell debt, whose repayment could be partly supported by property tax revenues, is a subject that “merits discussion” although such a move would require a change in the law.

The ability of domestic financial markets to adequately price such debt also needs to be studied, he said.

--Victoria Ruan. Editors: Nerys Avery, Fergal O’Brien

To contact Bloomberg News staff on this story: Victoria Ruan in Beijing at +86-10-6649-7570 or vruan1@bloomberg.net;

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net