CHINA CARRY TRADE OVER?

China to pursue higher returns on reserves
Beijing to create agency to oversee its investment of foreign currency reserves of more than $1 trillion; global investors wary of impact.

March 9 2007: 7:11 AM EST

BEIJING (Reuters) -- China is setting up a new investment agency to seek higher returns on its foreign currency reserves of more than $1 trillion, the largest stockpile in the world, Finance Minister Jin Renqing said Friday.
It was the first official confirmation of China's plans, which Premier Wen Jiabao foreshadowed in January by saying Beijing would actively explore new ways of using the reserves.
"The biggest priority is safety, and under the principle of security we will try to increase the efficiency of management and the investments' returns," Jin told a news conference.
He gave no details of how much money the fund would manage, let alone how it might invest, but he said Singapore's state-owned Temasek investment company would be one of its models.
"This company is still in the process of being formed, and it will let the public know when it has been formally set up," said Jin, who was speaking during the annual session of the National People's Congress, China's largely ceremonial parliament.
China's financial firepower means the fund has the potential over time to make a big impact on world markets.
"Some people in the market are concerned that if there is going to be a drastic change in the way the FX reserves are being managed, it could have a potentially important impact on capital flows and financial markets," said Grace Ng, an economist at JPMorgan Chase in Hong Kong.
Academic studies estimate that investment by China and other Asian countries in U.S. bonds has reduced long-term American interest rates by anything from half a percentage point to 2 percentage points - a boon to U.S. businesses and home buyers.
The State Administration of Foreign Exchange (SAFE), an arm of the central bank, currently manages all of China's reserves.
Where they are invested is a state secret, but bankers assume two-thirds or more are held in low-risk dollar bonds.
SAFE, which regulates China's currency, would continue to manage what Jin called China's "normal" reserves; the rest would be invested by the new agency.
As China's reserves have ballooned on the back of record trade surpluses, demands have grown for part of the hoard to be managed more aggressively.
Some researchers have argued for buying oil, natural resources and high-technology imports; others want the money to be converted back into yuan and spent relieving poverty at home.
Singapore model
Cheng Siwei, a leading lawmaker, told Reuters this week that China needed no more than $600 billion-$700 billion in reserves, and various state media reports have said the new agency could receive as much as $200 billion to manage.
Bankers, however, say a fund would take years to grow that big without driving the prices of assets it buys sharply higher.
To avoid rocking markets, one possibility for the new agency would to give it only part of China's new reserves, not its existing stash. The reserves are growing by about $20 billion a month.
"Given the way the Chinese government does things, it's likely to be a gradual process. Any impact on the market would likely to be gradual and manageable," said Ng at JPMorgan.
Reflecting the importance of the venture, the new agency will report directly to the State Council, China's cabinet, and not to either the finance ministry or the central bank.
Lou Jiwei, a former vice finance minister, was promoted to a cabinet-level post this week in a move that analysts saw as prefiguring his appointment to run the agency.
"We will draw upon the successful practices of other countries, for example Singapore's Temasek, to manage China's foreign exchange reserves," Jin said.
Temasek Holdings invests Singapore's fiscal surpluses, not its currency reserves. It owns stakes in several of Singapore's biggest firms and has expanded aggressively in Asia since 2002 to try to boost its long-term investment returns.
Temasek reported total shareholder return by market value of 24 percent in the year ending March 31, 2006, matching that of the city-state's main stock market index.
Over a 10-year period, its total shareholder return of 6 percent a year was also in line with the Singapore index.
Last year it paid $3.8 billion for Shin Corp., Thailand's biggest telecommunications firm, triggering a political crisis in Bangkok that culminated in a military coup against former prime minister Thaksin Shinawatra, who founded the company.
China has grown into an economic powerhouse in the last decade, becoming the home to manufacturing for products sold by Wal-Mart (Charts), Target (Charts), Lowe's (Charts), and Home Depot (Charts).
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