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By the end of March, China's foreign exchange reserve had seen a 37.36 percent year-on-year leap to reachUS$1.2 trillion, the People's Bank of China, the country's central bank, announced on Thursday.

"I'm not surprised at the figure," said Cai Zhizhou, an economist at Peking University, describing the sharp rise as now "normal."

China's forex reserve has seen significant leaps in recent years, standing at US$609.9 billion in 2004, US$818.9 billion in 2005 and US$853.6 billion just last year, allowing China to overtake Japan in having the largest forex reserve in the world.

"The rising trade surplus is the major factor contributing to the forex reserve boom," Cai pointed out, explaining that the low prices of Chinese goods fueled the trade surplus.

"The forex reserve is necessary to avoid financial obstacles as the dependence on foreign trade continues to rise," said Cai.

Risks could indeed plague China given the meteoric rise of its foreign trade in recent years, which has risen by over 20 percent annually since 2002 while the ratio of foreign trade to GDP has risen from 30 percent to 70 percent in the same period.

The rise in forex reserves can be directly linked to the trade surplus which peaked at US$46.44 billion in the first quarter, nearly double the US$23.3 billion seen in the same period last year.

However, the benefits of this rise are offset by the tensions it creates between China and its trading partners.

To strike a balance, China has lowered export rebates across a range of products, ranging from steel to textiles. This led to a slight cooling of the trade surplus, which lowered by US$6.87 billion for March.

Despite the encouragement that could be derived from such financial buoyancy, Cai did warn that "a large-scale forex reserve may backfire. It is the major reason leading to the excessive liquidity in China."

This problem is aggravated since the central bank is forced to spend basic funds in acquiring more foreign exchange.  Completing the vicious circle is the fact that forex reserve growth has placed more pressure to appreciate the renminbi, which in turn wields more pressure to maintain the overall value of the forex reserve.

If estimates hold firm, China's forex reserve will reach US$2.9 trillion by 2010 and China thus plans to launch a state forex investment company.

The investment company will first issue US$200 billion to 250 billion of RMB-denominated bonds with all subsequent money raised to prioritize strategic investment for energy enterprises like CNOOC, earlier reports revealed.

(Xinhua News Agency April 13, 2007)