LeveragedBuyout
SENIOR MEMBER
- Joined
- May 16, 2014
- Messages
- 1,958
- Reaction score
- 60
- Country
- Location
June 17, 2014, 7:29 p.m. EDT
What should China buy with its $3.9 trillion reserves?
By Ling Huawei
BEIJING ( Caixin Online ) — China’s foreign exchange reserves rose to $3.948 trillion at the end of the first quarter. The figure in 1978 was $167 million, and in November 1996 it surpassed $100 billion for the first time. The change has been amazing.
ABOUT CAIXIN
Caixin is a Beijing-based media group dedicated to providing high-quality and authoritative financial and business news and information through periodicals, online and TV/video programs.
• Get the Caixin e-newsletter
There have been many thoughts about how we in China can make use of the forex reserve, ranging from buying assets abroad to using it as leverage in diplomatic talks. What needs emphasizing is that the reserve is not a free buffet. It corresponds to the central bank’s debt in yuan and costs dearly to maintain.
In a traditional sense, the forex reserve is meant to serve as a buffer in times of emergency and is to be used for repayment of external debt. The basic requirement for its investment is guaranteeing the safety of the principal rather than pursuing high yields. This is true for even the part of forex reserve in excess of the amount required for ensuring its traditional purposes are met.
Also, it is important to know that 40% of the forex reserve came through operations under the capital account. In other words, about $1.6 trillion of the reserve, be it hot money or foreign direct investment, flew into China because the investors were betting on the country’s positive outlook.
If these investors want to take their investments out of the country, the government can take measures to slow the exit of capital, but there is no legal way to stop it. Granted, the odds are extremely low that all foreign investments would leave the country, especially if China sticks to the path of reform and opening up.
The other 60% of the reserve, which resulted from operations under the current account, correspond to the debt owed to companies and individuals who sold their forex holdings to banks. The reason they did not hold the money in foreign currencies is that investing in yuan is currently more profitable. Also, there is a lack of channels for private investors to invest overseas. That is why China’s forex investments are primarily conducted by the forex administrator.
These are the reasons the government cannot simply dish out the forex reserve to whoever wants a piece of it.
Bloomberg
How can the central bank manage the forex reserve? It can learn lessons from foreign countries. There is enough diversified data about how sovereign funds operate around the world. The essence is to introduce a corporate structure, improve management and bring in a professional investment team with incentives that encourage competition.
Also, the evaluation of investment returns needs to be done over the long term. Transparency is needed and so is a mechanism for public supervision. Temasek Holdings, Singapore’s sovereign-wealth fund, is a successful example. It went through many twists and turns when it was young, but has been able to achieve a lot by adhering to market-oriented practices. Recent figures show that its return on equity over the past 39 years was 16% a year.
The central bank’s State Administration of Foreign Exchange (SAFE) was established in 1979. The employees of its forex management department are the same people that work for the central bank’s forex businesses center. Both establishments are responsible for the management of the forex reserve.
They are governed the way a government-affiliated institution is, which allows for more flexibility in management compared with a government agency. Foreign nationals occupy some executive positions, and a lot of effort has been made to allocate the investments of forex reserve according to market demands. This is progress that should be recognized.
But there are limits as well. A government-affiliated institution is not a real company. It can never establish an efficient corporate governance structure as a real company, and its incentive mechanism will never be as effective.
There are not enough people managing the forex reserve. Foreign experience shows that every employee in big, global investment institutions manage on average $500 million to $800 million worth of assets. There are slightly more than 500 people on SAFE’s forex reserve management team. That means every one of them oversees about $8 billion worth of assets.
Given the huge size of China’s forex reserve, it is difficult for one or two companies to manage it alone. What we can do is set up several entities like China Investment Corp. (CIC) under SAFE, giving them different mandates and positioning them differently in terms of investment targets, areas and assets.
We can also inject capital into the CIC to enable it to set up subsidiary institutions that can compete with each other. Once these institutions are established, their rights and liabilities should be set out clear so whoever makes investment decisions is truly responsible for them and whoever shoulders the risk gets the reward. Competition between institutions should be encouraged. More importantly, there should be a mechanism for accountability to avoid moral hazard.
In the long run, the ultimate solution is to steadily push forward exchange-rate reform so the private sector can hold onto forex. Real, strong investors can only emerge from the public and from competition.
The model of Temasek has many lessons to offer, but there is one thing that China cannot copy because Singapore is a city-state whereas China is a huge country facing much more complex governance issues.
Also, the investment efficiency of sovereign-wealth funds can improve, but it can never match that of asset-management companies that win out in fierce market competition. So improving the private sector’s ability to invest and allocate assets globally is the direction China should be headed.
With this as the goal, the way forward can be worked out along the way.
Rewritten by Wang Yuqian
What should China buy with its $3.9 trillion reserves?
By Ling Huawei
BEIJING ( Caixin Online ) — China’s foreign exchange reserves rose to $3.948 trillion at the end of the first quarter. The figure in 1978 was $167 million, and in November 1996 it surpassed $100 billion for the first time. The change has been amazing.
ABOUT CAIXIN
Caixin is a Beijing-based media group dedicated to providing high-quality and authoritative financial and business news and information through periodicals, online and TV/video programs.
• Get the Caixin e-newsletter
There have been many thoughts about how we in China can make use of the forex reserve, ranging from buying assets abroad to using it as leverage in diplomatic talks. What needs emphasizing is that the reserve is not a free buffet. It corresponds to the central bank’s debt in yuan and costs dearly to maintain.
In a traditional sense, the forex reserve is meant to serve as a buffer in times of emergency and is to be used for repayment of external debt. The basic requirement for its investment is guaranteeing the safety of the principal rather than pursuing high yields. This is true for even the part of forex reserve in excess of the amount required for ensuring its traditional purposes are met.
Also, it is important to know that 40% of the forex reserve came through operations under the capital account. In other words, about $1.6 trillion of the reserve, be it hot money or foreign direct investment, flew into China because the investors were betting on the country’s positive outlook.
If these investors want to take their investments out of the country, the government can take measures to slow the exit of capital, but there is no legal way to stop it. Granted, the odds are extremely low that all foreign investments would leave the country, especially if China sticks to the path of reform and opening up.
The other 60% of the reserve, which resulted from operations under the current account, correspond to the debt owed to companies and individuals who sold their forex holdings to banks. The reason they did not hold the money in foreign currencies is that investing in yuan is currently more profitable. Also, there is a lack of channels for private investors to invest overseas. That is why China’s forex investments are primarily conducted by the forex administrator.
These are the reasons the government cannot simply dish out the forex reserve to whoever wants a piece of it.
Bloomberg
How can the central bank manage the forex reserve? It can learn lessons from foreign countries. There is enough diversified data about how sovereign funds operate around the world. The essence is to introduce a corporate structure, improve management and bring in a professional investment team with incentives that encourage competition.
Also, the evaluation of investment returns needs to be done over the long term. Transparency is needed and so is a mechanism for public supervision. Temasek Holdings, Singapore’s sovereign-wealth fund, is a successful example. It went through many twists and turns when it was young, but has been able to achieve a lot by adhering to market-oriented practices. Recent figures show that its return on equity over the past 39 years was 16% a year.
The central bank’s State Administration of Foreign Exchange (SAFE) was established in 1979. The employees of its forex management department are the same people that work for the central bank’s forex businesses center. Both establishments are responsible for the management of the forex reserve.
They are governed the way a government-affiliated institution is, which allows for more flexibility in management compared with a government agency. Foreign nationals occupy some executive positions, and a lot of effort has been made to allocate the investments of forex reserve according to market demands. This is progress that should be recognized.
But there are limits as well. A government-affiliated institution is not a real company. It can never establish an efficient corporate governance structure as a real company, and its incentive mechanism will never be as effective.
There are not enough people managing the forex reserve. Foreign experience shows that every employee in big, global investment institutions manage on average $500 million to $800 million worth of assets. There are slightly more than 500 people on SAFE’s forex reserve management team. That means every one of them oversees about $8 billion worth of assets.
Given the huge size of China’s forex reserve, it is difficult for one or two companies to manage it alone. What we can do is set up several entities like China Investment Corp. (CIC) under SAFE, giving them different mandates and positioning them differently in terms of investment targets, areas and assets.
We can also inject capital into the CIC to enable it to set up subsidiary institutions that can compete with each other. Once these institutions are established, their rights and liabilities should be set out clear so whoever makes investment decisions is truly responsible for them and whoever shoulders the risk gets the reward. Competition between institutions should be encouraged. More importantly, there should be a mechanism for accountability to avoid moral hazard.
In the long run, the ultimate solution is to steadily push forward exchange-rate reform so the private sector can hold onto forex. Real, strong investors can only emerge from the public and from competition.
The model of Temasek has many lessons to offer, but there is one thing that China cannot copy because Singapore is a city-state whereas China is a huge country facing much more complex governance issues.
Also, the investment efficiency of sovereign-wealth funds can improve, but it can never match that of asset-management companies that win out in fierce market competition. So improving the private sector’s ability to invest and allocate assets globally is the direction China should be headed.
With this as the goal, the way forward can be worked out along the way.
Rewritten by Wang Yuqian
.
