How to Manage China's Foreign Exchange Reserves?

Abstract

Financial crisis is not a new term to the world and has been through the financial globalization in the past decades. Many developing countries choose to stockpile a large amount of foreign exchange reserves to protect their economy from external shocks. However, given the declining value of the US dollar, the rapid built-up of reserves also creates a new debate on what amount and which form to hold for emerging economies. This paper attempts to address the two questions for China, the largest reserve holder since 2006. By performing an empirical analysis of 42 developing countries, a series of conclusions are drawn, including a major confirmation that China's holding of reserves exceeds the estimated adequate level. With a combination of telling evidence and theoretical interpretation, this paper provides a package of solutions to the issue of how to manage China's foreign exchange reserves in the long-term and short-term scenarios. To fundamentally slowdown the growth rate of reserves and reduce the aggregate amount, a shift in economic policies is desired. Meanwhile, taking into account the opportunity cost of holding, a course of proactive reserve management would be advisable.

Keywords: foreign exchange, reserves, China, reserve management

JEL Classification: E58, F31, F33