China FX chief says hard to invest in commodities

BEIJING: China cannot invest much of its foreign currency riches in the global commodities market, because doing so would only push up the prices of the raw materials that the economy depends on, the country's top money manager said on Saturday.

Yi Gang, head of the State Administration of Foreign Exchange (SAFE), also said that monetary easing in wealthy countries was driving down China's returns on its $2.85 trillion in official currency reserves, the world's biggest such stockpile.

He said it was not a simple matter for China to buy into oil or gold, which have soared in recent days with investors worried that political unrest in Libya could spread through the Middle East.

"Some have argued that we should buy oil, buy gold, buy iron ore, or even buy into companies and land. But it is much easier said than done," Yi said in a speech at Peking University.

"If we go into the spot market to buy commodities, we will immediately push up prices. These markets, compared to the size of our foreign exchange reserves, are too small.

"If China gets into these markets and pushes up prices to extremely high levels, the Chinese people will bear the cost at the end of the day as China is often the key buyer in these markets," said Yi, who is also a vice governor with the People's Bank of China.

As an example, Yi said that China had purchased more than 300 tonnes of gold last year through normal trade, and that it would have been harder to buy any more with foreign reserve funds.

"The gold price shot up last year, and surging gold prices have forced Chinese people to pay more as there is strong demand for gold for those getting married and other events."

Yi also said that it was not easy for China to use its reserves to conduct acquisitions. Global oil, iron ore and gold markets have their own rules and mechanisms, and it would be hard for China to shop around, he said.

HERBAL MEDICINE

Loose monetary policies implemented by wealthy countries in an attempt to power their economies towards recovery from the global financial crisis were another complication.

"Due to quantitative easing and near-zero interest policies, investment returns of (our foreign exchange reserves) are increasingly moving towards lower and lower levels. Although we have achieved fairly good returns through management, it should be said that the environment is not optimistic," he said.

"For me, that's a big challenge," Yi added.

To staunch the growth of its bulging reserves, Yi said that it was imperative for China to cut its current account surplus.

However, he said that China had to take "herbal medicine" in a mixture of gradual policies, rather than a radical approach.

"We will work hard this year to expand domestic demand a little bit; to reduce reliance on external demand a little bit; to increase wages and social insurance a little bit, enhance environment checks a little bit, reform resource pricing mechanisms a little bit, relax outbound investments a little bit, and make the yuan a little bit more flexible," he said.

STABLE YUAN

Keeping the yuan's exchange rate "basically stable" was still a policy aim for Beijing, he added.

Yi acknowledged that there were more calls for yuan appreciation from other developing countries such as India and Brazil, but he said that China has already gone a long way to reforming the yuan and allowing it to strengthen over the past five years.

Narrowing the current account surplus was also critical to dampening inflationary pressure, Yi said. Cash inflows via China's trade surplus have helped to push inflation to an annual rate of 4.9 percent, just shy of a two-year high.

Beijing has managed the excess cash by raising big banks' required reserves to 19.5 percent, a record, and some question how much more room it has to push reserves up further.

Asked whether he saw a ceiling on reserve requirements, Yi said that he had no research findings on that, but added that it was was worth studying the impact on commercial bank operations.

He said that the the central bank would continue to soak up excessive liquidity and that China would aim to keep inflation to an average of "about 4 percent" this year.