Essays On Structural Optimization And Chinese Foreign Exchange Reserve Management Strategy

It is to deal well with the issue of appropriate scale and currency composition thatforeign exchange reserve management is in essences. In the face of exchange rates volatility,interest rates variation, potential investment losses and the risk of domestic monetary policyfailure, Chinese huge foreign exchange reserve is deeply trapped in the dilemma of scaleadjustment and structure optimization. It is urgent to establish a set of strategic foreignexchange reserve management system with Chinese characteristics in view of the bad securityconditions of reserve assets. At the moment, there are a great number of literatures onappropriate scale and currency composition about Chinese foreign exchange reserve, whilenot enough attention has been paid to those researches about asset allocation, term structureand collaborative management for reserve and foreign debts. The latter lacks of full andaccurate discussions. This thesis is no other than a comprehensive discussion on theabove-mentioned four key issues of Chinese reserve management in such circumstances; aimsat exploring a set of realistic maneuverable reserve management modes with theoreticalfundamentals.The first chapter reviews relevant literatures from three perspectives of appropriate scale,currency composition adjustment and reserve management.The second chapter discusses the issue of rightsizing Chinese foreign exchange reserve.First, based on a small open economy model, we employ Pure-sign-restriction Approach inanalyzing the influence of reserve accumulation on China economy empirically. Second, theappropriate scale of Chinese foreign exchange reserve, which is supposed to meet thetransaction, precaution, insurance and management needs, is investigated by combininginternational experience, insurance contract model, small open economy model and historicalanalysis with China’s data. Third, the relation between foreign exchange reserve andsovereign wealth fund is discussed. At last, the adjusting approach about Chinese foreignexchange reserve scale is also explored. It is found that the accumulation of Chinese foreignexchange reserve is conducive to borrowing more short-term external debts falling due withinnext12-month and causes the substitution of short-term debts for long-term debts; is helpfulfor GDP growth and job creation, although it does form some short-term inflationary pressure.The appropriate scale standard of “8.1Monthly Import+1.91Short-term External Debt+15%Foreign Capital Utilization” is supposed to be used in the dynamic supervision forChinese foreign exchange reserve. In the meanwhile, issuing special bonds for purchasingforeign exchange reserve and achieving capital injection into CIC may become normalizedoperation mode for Chinese foreign exchange reserve scale management. The third chapter addresses the issue of optimizing the currency composition of Chineseforeign exchange reserve. At the beginning, we conduct a research on possible currencycomposition of Chinese foreign exchange reserve combining TIC report with COFER data.Next, the optimal currency composition of Chinese foreign exchange reserve is studied withinthe Mean-Variance analysis framework by utilizing DCC-GARCH model for estimating thetime-varying correlations of returns. In the end, dynamic optimization approach is applied toexplore specific adjustment route. The results illustrate that Chinese foreign exchange reserveconsists of60%~65%Dollars,25%~30%Euros,5%~7%Sterling Pounds, and3%~5%Yens. It is weak dollar and exorbitant dollar share that have become one of the key riskysources of Chinese foreign exchange reserve. Converting part of dollar assets to yen assetsaccording to the dynamic optimal route will lower the risk effectively. Blindly decreasing theshare of euro assets should be avoided.The fourth chapter investigates the issue of asset allocation and term structurearrangement about Chinese foreign exchange reserve investment. First of all, we make ananalysis on possible asset allocation and investment term structure by doing data miningabout IMF-GDDS template, China International Investment Position, TIC report withreference to the asset composition of Brazil foreign exchange reserve. Then, the allocation ofreserve asset on stocks and securities is studied by using Aizenman-Glick Model and the basicthought of Stackelberg Model; the proportion of short-and long-term bonds is analyzed bymeans of Cox-Ingersoll-Ross Square-root Model. Besides, we also make a discussion aboutthe adjusting orientation of Chinese foreign exchange reserve investment. The researchdemonstrates that Chinese foreign exchange reserve is composed of95%securities, whichinclude90%long-term bonds,1%short-term bonds and9%equity,2%currency and depositsand3%other financial tools. The share of equity investment in Chinese foreign exchangereserve appears insufficient. As for reserve investment in U.S. public debt market, it isunnecessary to consider market timing selection. Discriminatory asset allocation based onpartitioning Chinese huge foreign exchange reserve into appropriate and excess part iscapable of enhancing investment returns.The fifth chapter explores the issue of collaborative management about foreign reserveand external debts. We explain the necessity of cooperative optimization at first, and thenmake deep analysis on the structure of Chinese external debts. Furthermore, the preliminaryapplication of Immunization Strategy and Cash Flow Matching Strategy derived from fixedincome portfolio theory in Chinese foreign exchange reserve management obtains fullydiscussion. It is convinced that the collaborative management about foreign reserve andexternal debts is of key importance for the robust expansion of China economy. Researchesshow that as of June,2012, medium-and long-term debts account for25.08%, and short-termdebts occupies74.92%; in term of currency composition, Chinese foreign debt is comprised of77.77%Dollars,7.51%Euros,6.99%Yens and7.73%other currencies. The duration ofreserve assets ought to be adjusted in accordance with that of Chinese external debts. Thecash flow of reserve is supposed to match that of the debts.The sixth chapter proposes a strategic concept about the management and optimizationof Chinese foreign exchange reserve. In the aspect of short-term tactics arrangement, StateAdministration of Foreign Exchange should set up strategy foreign exchange reserve riskmanagement framework; evaluate and supervise the appropriateness of Chinese foreignexchange reserve dynamically; regulate the currency composition according to dynamicoptimal route; consummate the entrusted operation system; build up structural optimizationindex; and improve reserve risk management system. In the aspect of medium-term strategy,the construction about strategic goods storing system backed up by excess foreign reserveshould keep going on unswervingly. China should positively participate in constructing EastAsian Foreign Exchange Repertory and make solid progress in asset diversification as well asthe globalized allocation for national assets. Meanwhile, how to utilize excess reserve forcovering pension shortage is supposed to be studied comprehensively. Besides, StateAdministration of Foreign Exchange should partake in European Rescue Project moderately.In the aspect of long-term strategy, the project of Renminbi internationalization should becarried out steadily, and citizens should be encouraged to hold reasonable foreign assets. Inaddition, domestic economic restructuring and the rebalance between China and the worldeconomy are the two ultimate approaches for reserve risk management.