• Rationale behind China’s high Forex Reserves and stable exchange rate

    China’s Forex reserves touched a record high of USD 3 trillion in May 2011 which is much higher than the second place ofJapan’s USD 1.2 trillion Forex reserves.India’s Forex reserves stands at around USD 300 billion.

    Chinacontinuously try to boost its trade activity and industrial output to deliver fastest GDP growth in the World continuously.China’s GDP has been growing around 10% on an average for last one decade and its huge Forex reserves were used to support the dream run.

    China’s Strength as an economy?

    Chinais the world’s largest exporter and second largest economy by size. It is mainly an export driven economy and most of its industrial products were exported to all the other developed nations. Its export is much higher than its imports with trade surplus at around USD 13 billion level for last month (May 2011). These huge export and trade surplus drive its GDP growth to the fastest 9% average level.

    Effect of trade surplus on Currency?

    As we all know that high trade surplus increases the foreign currency (rather US Dollar considering it to be globally used) supply within the country. High US dollar supply within the country results in appreciation of its local currency Chinese Yuan. Local currency appreciation affects the export industry and it reduces the income in local currency term and reduces the profitability as well. Any adverse effect on  its export industry will have significant impact on its GDP growth.

    How does China provide support to its export industry?

    To keep its export industry strong and profitable,Chinahas decided to keep its currency undervalued or acts against any kind of currency appreciation immediately.Chinahas also kept the exchange rate movement range very narrow to stop any sudden movement of currency in any direction.

    Source of high Forex Reserves?

    We all know that huge Trade surplus every month is bound to increase the dollar supply within the country and to appreciate the local Chinese currency significantly. To keep the local currency undervalued and stop any currency appreciation,Chinabuys dollar continuously to offset the effect of high dollar supply. The intensity of dollar buying is almost same as trade surplus every month and very high to absorb so many dollars from the open market. Because of continuous high amount of dollar buying every month,China’s Forex reserves are surging every month to record high.

    Now we understood whyChinahas so much Forex Reserves.Chinamainly increases its forex reserves to support its export industry. That is the best way to drive its GDP growth.

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