The Condition and Problems of the Practical Use of China's Foreign-Exchange Reserves

Although it controls monetary policies, a central bank can occasionally experience a situation where its financial situation worsens and excessive liabilities occur. In such instances, the central bank may be unable to fulfill its policy objectives. This study focuses on the People's Bank of China (PBC), which is the central bank of China and possesses large foreign reserves, and investigates whether the costs it has incurred during its intervention in the foreign exchange market have contributed to its present financial situation. We then discuss future estimated PBC results. Against the background of an expanding international balance of payments surplus, the PBC continued intervention in the foreign exchange market to ensure Renminbi exchange rate stability. This intervention rapidly increased foreign reserves. This study examines the PBC balance sheet to estimate the costs of its foreign exchange market intervention after January 2002 using several assumptions. The results show that the losses experienced through its intervention policy are expansionary, and were 18.5% of its overseas assets by the end of 2011. Analyzing the factors affecting intervention costs individually, we see that exchange rate changes have a higher impact than interest rate fluctuations on intervention costs, and this effect can be identified at an earlier stage. The study concludes that the improvement of its financial situation, whilst still fulfilling its monetary policies, will be a significant challenge for the PBC.