China's Currency Reserves Rise 36% to $1.81 Trillion

By Nipa Piboontanasawat

July 14 (Bloomberg) -- China's foreign-exchange reserves, the world's biggest, climbed to a record $1.81 trillion at the end of June as regulators failed to stem inflows of speculative capital from abroad.

Currency holdings rose 35.7 percent from a year earlier, the People's Bank of China said today on its Web site. The assets grew $126.6 billion from the end of March, after a $153.9 billion gain, the biggest on record, in the first quarter.

Chinese regulators are adding controls this month to limit ``hot money'' inflows from investors betting the yuan will keep appreciating after 25 straight monthly gains. The trade surplus, foreign direct investment and speculative capital have flooded the world's fourth-biggest economy with cash, threatening to stoke inflation that rose to a 12-year high in February.

``A huge amount of money is coming into China and betting on the Chinese currency,'' said Dwyfor Evans, an economist at State Street Global Markets in Hong Kong. ``This is creating an inflation impact and has become a big worry for policy makers.''

The yuan has climbed versus the U.S. dollar every month since May 2006. It rose today to the highest since a peg to the dollar was scrapped in 2005, trading at 6.8310 versus the dollar as of 12:17 p.m. in Shanghai.

Speculative inflows may have reached more than $200 billion in the first five months, according to Michael Pettis, a finance professor at Peking University. The trade surplus narrowed 12 percent to $99 billion in the first half from a year earlier, while foreign direct investment climbed 46 percent, pumping $52.4 billion into the financial system.

Limited Options

The extra cash is limiting policy makers' options. The central bank has kept interest rates unchanged this year, after six increases in 2007, on concern that higher rates would only attract more money from abroad. Instead, it has quickened the yuan's gains versus the dollar to double last year's pace and ordered banks to set aside a record 17.5 percent of deposits as reserves.

Money supply grew at a slower pace last month, the central bank said today. M2, the broadest measure, climbed 17.4 percent, compared with an 18.1 percent gain in May.

More increases in the reserve requirement are likely and the central bank will also keep selling bills to soak up cash, Wang Tao, a Beijing-based economist with UBS AG, said in a July 2 report predicting ``continued rapid accumulation of foreign- exchange reserves'' this year.

The State Administration of Foreign Exchange, China's currency regulator, said this month that it will inspect exporters' foreign-exchange settlements from today to try to prevent sham transactions letting speculative capital in.

China is also drafting regulations to control cross-border payments for services, with the same aim, according to an official at the regulator, who wouldn't be identified.

Besides inflows of money, the currency reserves are swelled by returns on investments and a U.S. dollar slump that increases the value of holdings in other currencies. The government set up last year an investment arm, China Investment Corp., to invest some of the money for bigger returns.

To contact the reporter on this story: Nipa Piboontanasawat in Basel at npiboontanas@bloomberg.net