Business China

CHINA made "a big mistake" accumulating huge foreign currency reserves that have provided it with little returns, said Nicholas Lardy, a senior fellow at US-based Peterson Institute for International Economics.

It is a mistake because the returns on these assets are "extremely low" given the low interest rate environment in the US, said Mr Lardy at a dialogue session on China's strengthening financial power at the FutureChina Global forum at The Ritz-Carlton.

This inability to maximise growth, in turn, has constrained China's potential to be a financial power. And it is reflective of the distortions relating to its domestic financial markets and its exchange rate.

"So China is a 100 pound gorilla – or whatever you want to call it – that is really not able, as yet, to translate that into a commensurate position in international financial markets."

Fellow panellist Xiao Geng, a professor and director of the Columbia University Global Center in Beijing, agreed that China has been hindered by the size of its reserves.

Said Prof Geng: "For most this is a strength, but actually it reflects weakness."

China's growing foreign reserves are a result of a huge trade surplus – which was "not intended" by its government, he said. It is also the result of the speculative holding of yuan assets against US dollar assets by both the Chinese people and foreigners.

The Chinese, he said, "think that the exchange rate is going to appreciate...so they want to hold RMB (renminbi) assets", said Prof Geng.

What the country needs to do is to decrease its trade surplus by increasing imports – which can be done by increasing domestic investment and consumption – something that will prove challenging for the current regime given its recent moves to cool the economy.

It also needs to allow the inflation rate to rise to reflect price increases more accurately, said Prof Geng.

With inflation, the yuan would depreciate and the Chinese people would have less incentive to hold yuan assets over US dollar assets, he said.

The exchange rate will also appreciate, which will drive imports – and lower China's trade surplus.

Another issue limiting China's ability to wield significant global financial influence is its small financial footprint beyond its own shores despite a strong net financial asset position.

According to Mr Lardy, less than one per cent of global direct investment comes from China. Its offshore lending is also not very significant. "So I would say that they are punching below their weight," he said.

Even if it tries to invest aggressively, its investments are viewed with a wariness that has hampered its attempts, particularly in the US.

"Speaking strictly as an American, I think the unfortunate fact is that China is not really very welcome in the US as a direct investor.

"We have a complicated regulatory process and there are many, many examples of attempts by Chinese companies to acquire firms in US through merger and acquisition activity that has not been approved, or has fallen on the wayside because of objections that have been raised," said Mr Lardy.

Even when the investments are not M&A related, there is a great reluctance in the US to welcome funding from Chinese firms, particularly from companies that are state-owned or perceived as having state ownership, he added.

One way to work around this is for China to invest domestically, said Prof Geng. Investments in China have, over the last 30 years, seen a 30 per cent return, said Prof Geng. In Japan, this is about 20 per cent over the same time period, and in the US, 5 per cent.

"If you just look at the return on investment, the Chinese and foreign investors should invest in China," he said.

China's huge reserves 'a big mistake': economist