Overseas investment

Analysis: China targets excess liquidity in hope of solving economic challenges

1970-01-01 08:33:27

        


The Chinese government unveiled two dramatic measures on Wednesday to solve its economic dilemmas with a massive issue of special treasury bonds to buy its ballooning foreign exchange reserve and cutting the country's longstanding interest tax on personal savings.

Both are intended to harness the excess liquidity in the domestic economy, said Finance Minister Jin Renqing. The cash in circulation has been blamed for the skyrocketing rise of the stock market and real estate prices that hint at an emerging economic bubble.

The two bills -- one authorizing the Ministry of Finance to issue 1.55 trillion yuan of special T-bonds for the purchase of 200 billion U.S. dollars of the forex reserve and the other authorizing the State Council to suspend or cut the interest tax on personal savings -- were tabled with the national legislature for review on Wednesday.

"China's excessive liquidity, as a result of unbalanced international trade and economic order, has also given rise to constant trade friction with foreign countries and inflation risks at home," said Dr. Yin Jianfeng with the Finance Institute of Chinese Academy of Social Sciences.

The proposed T-bond issue, the largest in China's history, would be very noticeable in its intended role of withdrawing currency from circulation, and the proposed cut or suspension of the tax on personal savings interest would make saving more attractive, Dr. Yin said.

Another intended goal of the T-bonds was to relieve the government of the burden of its increasing foreign exchange reserve, which stood at 1.2 trillion U.S. dollars by the end of March, up 135.7 billion U.S. dollars from the end of 2006.

According to the International Monetary Fund standard, forex reserves bought through T-bonds are no longer counted in the national foreign exchange reserve, and once the transaction is completed, a sixth of China's forex reserve will be in the hands of market players.

"Without a sufficient scale, the intended role of draining liquidity may not be obvious," he said. "Because China's forex reserves were likely to continue to rise, and the central bank would face more pressure in coping with excessive liquidity even after recent measures to withdraw currency from circulation."

The bond issue, whose dollar purchase would be managed by an forex investment company still in the making, will help domestic enterprises do business abroad and enhance national economic competitiveness, Jin said.

The proposed cut or suspension of the 20 percent interest tax on savings is seen as a means to dampen public enthusiasm for the stock market, which the government clearly wants to control.

In recent months, China has seen large sums of money flow from savings accounts into stock trading accounts. Household deposits posted the largest ever monthly drop in May, down 278.4 billion yuan, according to central bank statistics.

"A bull stock market and soaring housing prices made many people realize that the yield on bank deposits was simply too low, " said Huang Fuguang, a finance professor at Tianjin-based Nankai University.

China's stock market has risen more than 45 percent this year after climbing 130 percent in 2006.

DOUBLE-EDGED SWORD

The proposed measures, widely eyed by economists as more effective ways to deal with the economic dilemmas facing China, will help put the economy on a safer track, but they come with risks.

The Financial and Economic Committee, a powerful economic affairs arm of the NPC, supported the State Council bill in a separate report to lawmakers on Wednesday, but it urged the government to speed up the process of formally establishing the forex exchange investment company by issuing detailed management methods and improving its risk management and market operation mechanism.

"Such measures are necessary because the treasury bonds are huge in scale and incurring interest must be considered," the NPC committee said.

"In face of the volatile international economic situations, the funds should be managed under tight supervision," it said.

Moreover, the proposed measures may need extra time to see their goals realized.

Despite the discussions on the draft bills which may drain liquidity, China's benchmark Shanghai Composite Index on the Shanghai Stock Exchange closed at 4,078.6 points on Wednesday, up 2.65 percent or 105.23 points from the previous close.

Dealers said some investors continued to hunt for bargains, with banks shored up by the news that the government would soon cut or reduce taxes on interest income from bank deposits.

Source: Xinhua