Research On The Management Of China's Foreign Exchange Reserve

Foreign exchange reserve is of great imporce for the monetary authorities and it is a guarantee to melt the deficits of balance of payment, interfere with the foreign exchange market so as to maintain the stability of the local currency and a creit backup to borrow and repay the foreign debts.With the dramatical increases in the scale, two changes have taken place in the functions of foreign exchange reserve since Asia financial crisis. On one hand, foreign reserve'core function turned to"keep confidence". On the other hand, foreign reserve was regarded highly as a wealth of the whole country.In managing practices of foreign exchange reserve, there are some changes responding to the functional shifts:Firstly, optimize the scale-related management. The reserve is divided into two tranches respectively: the regular tranche which focuses on the basic functions of foreign reserve, and the excess tranche which focuses on returns objetive.Secondly, diversify the structures of foreign reserve. There are two subsets in the structur: currency composition structure and assets structure.Thirdly, there is a new trend in the managing frameworks. Countries with amount foreign reserve scale tend to manage their reserve"actively". That is to build a professional investing institution to manage the excess tranche of reserve.For China, foreign reserve has expanded rapidly in recent years, which ranked the NO.1 in the world. The impressive pace of reserve growth has become a hot issue. The great bulks of reserve caused some risks and costs for the economy, such as opportunity cost, pressure on inflation, restriction on the independence of monetary policies, etc. How to effectively manage the foreign reserve to keep actual purchasing power and revaluation of the reserve assets is a practical and important issue. This paper tries to examine this problem theoretically and give some advice on policy choices.The key points needing to be studied are:1. Given the background of financial industries opening-up, what is the exactly theoretical amount of regular tranche focus on the liquidity and security?2. What kind of adjustments should be made in the structures of foreign reserve?3. How does China build a foreign reserve management framework which is suitable to Chinese conditions? How does the"active management"put into effect? What kind of law-related backup needs?4.How to optimize the whole foreign reserve management regime?The paper is organized as follows:Section 1 is the introduction of this paper. It carries out firstly an analysis on the background and significance of studying the management of Chinese foreign reserve. In the following context of the part, it demonstrates its research methodologies, structure, and contents, innovative breakthroughs. Then, it gives a brief introduction of the developing process of the international currency system and the conditions needed for currency internationalization. It argues that the currency internationalization should base on the strong sovereign credit.Section 2 studies the scale-related management of foreign reserve. Firstly, we give a brief literature review of the foreign reserve'optimal level. Secondly, we studied the changing conditions of the whole world's foreign reserve. Then, we emphasize on the changes in the Chinese condition. It argues that the scale of Chinese foreign reserve has beyond the optimal level dramatically since 2002. And the marginal cost has been greater than the marginal return. So the scale-related management should be innovated.Section 3 presents a detailed analysis of the structure- management of foreign reserve. There are two subsets:currency composition structure and assets structure. Based on the analysis of existed literatures, trends in the world and china's situations, the paper argues that China should adjust its currency composition gradually not abruptly. The position of dollar assets should be decreased and that of euro and the currencies of Asian EMC be increased. As to assets structure, it is a better choice to take on higher return-risk matching products. Thirdly, the paper argues it should set different benchmark for the structure of regular tranche reserve and excess tranche reserve.Section 4 exams the active management experiences of some counties, from which China can learn some lessons.Section 5 presents thoroughly analysis of the management regimes of foreign reserve in china .At the base of the analysis on the developing route of the foreign reserve management systems, it illustrates the necessity of innovation. In practice, China has carried out two important trials: HuiJin and CIC. It gives some analysis to them. Then, it discusses the general principle in the active use of foreign reserve. Lastly, it discusses the necessary improvements of foreign exchange reserve management regime in China. It argues that China should build a multi-storied foreign reserve management regime. That is, foreign exchange reserve should be divided into liquid tranche (regular tranche) and investing tranche (excess tranche), and the two tranches are managed by Central Bank and CIC respectively. Moreover, it argues that China should set up a foreign reserve strategy commission to get the harmony and consents among multi-departments and high efficiencies in management.Section 6 is the conclusion. The major arguments and results are summarized in this part. And the limitation of this paper and future questions are addressed.This paper attempts to make some innovative breakthroughs in the following aspects:1, with the adjusted data from the Survey of Foreign Portfolio Holdings of U.S. Securities and adjusted data of Chinese foreign reserve, it tries to give a more exactly description of the position of dollar assets in China's foreign reserve.2, it discusses the general principle in the active use of foreign reserve.3, it proposes the foreign exchange reserve should be divided into liquid tranche (regular tranche) and the excess tranche (investing tranche) for more effective management. And different benchmark should be set for the structure of different tranches.4, it proposes that China should set up a foreign reserve strategy commission to get the harmony and consents among multi-departments and high efficiencies in management.