Chinese Economy - China Central Bank Sets New FX Reserve Ratio
November 12, 2004
The Bank of China announced this week that it would take further measures to control the country's ever-expanding foreign currency reserves. The central bank plans to unify the reserve requirement for Chinese and foreign banks drawing deposits in foreign currency, in an effort to streamline the administration of foreign reserves and afford equal treatment to overseas banks. Starting from January 15, 2005, all banks that offer foreign currency deposit services in China will be subject to a 3% reserve requirement.
Both international and Chinese observers have interpreted the announcement as a possible preparatory step toward the relaxation of the government's RMB currency control policy. Many believe that the central bank intends to thoroughly restructure and integrate the management of foreign currency reserves, and that the measures taken this week will become an important tool for curbing the flow of hot money and foreign currency into the country.
The reserve requirement for foreign currency deposits, also known as the foreign exchange reserve ratio, refers to the rate of reserves to deposits set by national banking authorities. The new unified reserve ratio will require that 3% of all deposits of foreign currency in China, whether at a domestic or foreign bank, be held in reserve at the central bank.
Until now, China applied different standards to foreign banks and domestic banks in regards to the foreign exchange reserve ratio. The current rate for domestic banks is a flat 2%, but for foreign banks, the rate is 3% for deposits with maturity of three or more months and 5% for deposits with terms less than three months. The unification of the reserve ratio will level the playing field in this regard, allowing foreign banks to operate on the same footing as their Chinese counterparts.
The one percent increase in the reserve requirement for domestic banks aims to scale back foreign currency reserves and limit capital flows that continue to put upward pressure on the RMB exchange rate. A flurry of corporate loans taken in US dollars in recent years has prompted the government to put the brakes on growth of foreign currency loans. Earlier this year, the National Development and Reform Commission placed a cap on the amount of hard currency that foreign banks could bring into the country from overseas.
At the end of the third quarter 2004, China's foreign reserves totaled approximately US$540 billion.