An Analysis of the Determinants of the Changes in China’s Foreign Exchange Reserves’ Nominal and Real Rates of Return

Abstract

We use decomposition and regression to examine the reasons for the changes in nominal and real rates of return of China’s foreign exchange reserves between 2002 and 2009. The results show that the US financial market risk premium is the most important determinant of changes in the nominal rate of return, while the US dollar exchange rate and the bulk commodity price are the two key determinants of changes in the real rate of return. From empirically based research, one may conclude that the loose monetary policy of the US Federal Reserve increases China’s foreign exchange reserves’ nominal rate of return but decreases the real rate of return and that the European debt crisis has an uncertain impact on China’s foreign exchange reserves’ nominal rate of return but may well raise the real rate of return.