Ba Shusong
The much hyped State investment company set to be launched faces
multiple challenges ranging from establishing transparent
management under laws as yet to be written to showing solid
financial gains.
Zhou Xiaochuan, governor of the People's Bank of China the
central bank revealed during the National People's Congress session
that policymakers are tapping new channels to expand the investment
scope of the country's huge foreign exchange reserve.
Hu Xiaolian, head of the State Administration of Foreign
Exchange (SAFE), also said that the State investment company will
be established this year, although details are yet to be hammered
out.
The new company is expected to be under the direction of the
State Council, China's Cabinet, while professional managers will
handle the reserve fund.
Most of the world's state foreign exchange investment companies,
such as Singapore's Temasek Holdings, have had only a limited scale
of investment funds.
In contrast, in China, even if the company's initial fund is
US$200 billion, as the market expects, and it is not increased, it
will be the largest investment company in China.
Moreover, the fund is expected to grow.
Such a large scale fund will attract attention from the
international market. The managers of the fund must be adept at
maneuvers in the international capital market and familiar with
global economic growth trends.
The managers will undoubtedly face pressure for proper
management. The new company will also face pressure for
earnings.
The company is expected to sell bonds in the market to buy
foreign exchange funds from the central bank. It will then use the
foreign exchange fund for investment. The goal obviously is to have
a higher rate of return on investment through professional
management.
The cost of its capital, however, could reach 10 percent if
taking possible renminbi revaluation into consideration. Given the
cost level, it will be a challenge for the company to hire top
professionals and establish a transparent information disclosure
system to raise investment returns.
International experience shows that the foreign exchange reserve
should be diversified to satisfy different policy strategies.
For China, as it manages its reserve fund, it is necessary to
divide it into three categories: investment with high liquidity to
prevent risks, earnings-targeted long-term assets and assets aimed
at long-term value.
Considering the huge scale of the reserve fund, China needs to
further clarify the fund's different functions. Meanwhile, a
rational fund allocation regime should be established.
The establishment of the State investment company can reduce the
hedging pressure on the central bank and will have a positive
effect on China's monetary policy.
However, as the company issues bonds to purchase foreign
exchange, it actually involves a transfer of policy costs from the
central bank to the fiscal departments as the company is a State
establishment and the State is the de facto guarantor for the
bonds.
The issuance of the bonds will have a positive impact on the
domestic bond market, possibly improving its structure.
Meanwhile, many foreign investors, especially US-based ones,
will pay close attention to the new company. They will care about
whether the reserve fund used for investment will be funded through
selling China's US treasury bonds on the US market or by
transferring China's newly increased reserve.
Moreover, if the United States does not open some of its markets
that have been off-limits, there will not be much investment from
the State company flowing into the US market.
Currently, the legal framework for managing the foreign exchange
reserve is yet to be updated.
The law governing the People's Bank of China has relevant
articles but they are only general principles.
The regulation of foreign exchange management, on the other
hand, has no stipulations on management of the foreign exchange
reserve fund and needs to be amended.
The lack of legal clarification may stem from the misconception
that the reserve is a free lunch and needs no detailed
regulation.
Therefore, relevant legislation needs to be in place and a
stricter management regime needs to be established to govern the
fund's management. China's foreign exchange reserve management
regime has been improving in recent years. Starting last April, the
central bank has reformed policies on foreign exchange accounts
under the current account, service trade settlement and individual
purchasing of foreign currency.
As a result, procedures for individuals to purchase foreign
currency have been simplified. The limit on corporate foreign
exchange accounts under the current account has been eased. And
enterprises with real need for foreign exchange have been allowed
to make purchases without prior approval.
Regarding capital outflow, the central bank, the banking
regulatory commission and SAFE released a regulation last April. It
allows domestic institutions and individuals to invest overseas
through domestic commercial banks. SAFE later further expanded the
scope of investment channels for domestic institutions and
individuals to invest overseas.
Such policy changes marked a shift from the past practice of
strictly controlling capital outflow to promoting balanced capital
flows.
The author is a researcher with the Development Research
Center of the State Council
(China Daily March 23, 2007)