Finance & economics | China's reserves

A money machine

The People's Bank of China is the world's most profitable bank

| hong kong

CHINA wants to boost the return that it earns on its $1 trillion-plus stash of foreign-exchange reserves. The prime minister, Wen Jiabao, said on January 20th that the country would explore new ways of investing the money, which is held mostly in liquid American government securities. But his statement was vague. It could simply imply broadening the composition of assets held by the People's Bank of China (PBOC) to include higher yielding equities and commodities; or, more dramatically, part of the reserves could be transferred to a separate state investment agency which would maximise returns like a fund manager.

Even as things stand, the PBOC is earning a handsome profit. According to Stephen Green, an economist at Standard Chartered, it made a profit of $29 billion last year—more than any of the world's commercial banks.

Much attention has been given to the large losses that the PBOC could suffer if the yuan rose sharply against the dollar (in which around 70% of reserves are held). Last year, the loss on its dollar reserves, as a result of a modest rise in the yuan, was partially offset by a gain on its euro-denominated reserves as the euro strengthened. Mr Green estimates that, overall, the bank suffered a balance-sheet loss of 26 billion yuan ($3.3 billion) because of currency movements.

However, this loss was dwarfed by the PBOC's net interest income. It earned an estimated 343 billion yuan on its foreign reserves last year. On the other side of the ledger it had to pay interest of 90 billion yuan on banks' reserves held at the central bank and on bills it issued to absorb excessive liquidity (largely caused by the surge in foreign-exchange reserves). Putting this with the foreign-exchange loss gives a total profit for 2006 of 227 billion yuan, or $29 billion. Citigroup and Bank of America, the world's most profitable banks, each made net profits of just over $21 billion in 2006.

The PBOC's earnings are vast partly because the interest rate it pays on its own bills is much lower than American interest rates, so it makes money from mopping up the liquidity created by an increase in reserves. This means that as long as American rates remain above those in China, today's exchange-rate regime—of buying dollars to hold down the yuan—will remain profitable.

This article appeared in the Finance & economics section of the print edition under the headline "A money machine"

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