Abstract
We combined foreign reserves, capital control and financial depth with other economic variables in the same model and discussed the factors that affect the demand of China’s foreign reserves. The results showed that 1) a considerable number of foreign reserves are passively accumulated, for instance, stronger capital controls deeper financial system will lower the demand of foreign reserves; 2) the ratio of Hot Money/GDP is more significant than the FDI/GDP as a proxy of foreign reserves’ protective demand.
Highlights
At the end of 2013, China held a huge stock of international reserves at the amount of US$ 3821.3 billion foreign exchange reserves, which is far more enough to prevent financial risks
+ γ 6STEDt−1 + γ 7 APIt−2 + γ 8 FDIt + εt which RES means the ratio between the newly added reserves and GDP, opportunity cost (OC) is the differentials between 3-month Treasury Bill Rate and China’s 3-month Redemption Rate, HM is Hot Money/GDP, EXVOL is the expected volatility of RMB exchange rate, FOFX is the ratio of FOFX and GDP, is the differential between benchmark interest rate of China’ monetary market and US$ LIBOR, short-term external debt (STED) is STED/GDP, average propensity to import (API) is the amount of import/GDP, FDI is FDI/GDP
HM/GDP is more proper variable as an indicator for the productive demand of foreign reserves, 3) with the consideration of capital control and financial depth, the coefficients of demand in transaction, protection and speculation are, though still significantly, all witnessed huge drops by 60%, 70% and 40%, separately. They illustrated that huge amount of foreign reserves are accumulated actively, but passively, because of the immature of financial system, especially the foreign exchange management. 4) and we found that the strict capital controls cause passively accumulation of foreign reserves
Summary
At the end of 2013, China held a huge stock of international reserves at the amount of US$ 3821.3 billion foreign exchange reserves, which is far more enough to prevent financial risks. Most research about China’s foreign exchange reserves are basically admitted that international capital could flow in and out of China with few restrictions. The capital controls are not under consideration, which probably cause miscalculation on the optimal quantity and the opportunity cost of foreign exchange reserves. This paper will show significance theoretically and practically by integrating capital controls and other variables to re-estimate the foreign exchange reverses demand model
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