The Hindu Business Line : China follows Singapore model

The repercussions of China's putting a part of its reserves into global stock markets can be quite significant. While the move may set off a bullish trend in markets around the world, the shift of large sums from the US bond market will lead to higher interest rates and a weaker dollar. The net effect of the transactions has thus to be watched before India decides to follow suit, cautions S. VENKITARAMANAN.

Temasek, the company that manages Singapore's $100-billion-plus dollar reserves safely and profitably, has proved it is a model worth replicating. Only last year, Singapore's Senior Minister, Mr Lee Kuan Yew, had spoken of the stellar returns of the firm, of which he had been Chairman for 25 years. The Senior Minister had stated even then that some Asian countries, including South Korea and China, were to follow the example.

Now, there is official confirmation that China has decided to set up a company to manage part of its $1-trillion-plus reserves.

The Chinese Finance Minister, Mr Jin Renqung, said last week that part of the reserves would be managed by a foreign exchange management company under the control of the central executive branch — the government.

The Governor of the Chinese central bank has confirmed this initiative and indicated the name of the chief executive of the proposed firm.

The announcement is opaque about the level of reserves to be managed by the agency more aggressively and the extent to which the assistance of private investment agencies, such as investment banks, will be taken.

Chinese Government sources are also reportedly of the view that these resources should be partly used for acquiring control over natural resources as well as technology companies.

There is a plan afoot for using the dragon's financial might in useful and innovative directions. We in India are adept at following the Chinese example in many areas.

Hopefully, this is also an area for making effective adaptation, with care to introduce amendments based on Indian characteristics.

Managing the reserves

Obviously, the suggestion to set up a Government agency to part-manage the RBI's forex reserves more aggressively than hitherto is bound to encounter various objections.

First, it would be conventional wisdom that the Indian reserves are built up more out of volatile capital flows and equally volatile NRI deposits, which can erode over time, than out of current account surpluses.

This enforces the need for segregating a part of the reserves that can be traced to more sustained flows.

Unfortunately, we do not have access to current account surpluses that are the main strength of China's reserves. Our current account has been in deficit of late.

This means, it is important that even as we embark on an aggressive policy of market-related investment of part of our forex reserves, we should concentrate on undertaking an export enhancing policy that would reverse the current account deficit.

Huge market impact

It is interesting to note from the Table that China alone has over $1 trillion. China's neighbours, which imitate its savings habits, such as Taiwan, Hong Kong and Singapore, have between themselves another $300 billion.

While they do not necessarily follow China's direction, they do follow its example, except that in the current episode China has followed Singapore.

It is only a question of time before these other countries also set up Temasek-like enterprises. Consider that they will be involved in a massive stock operation comprising $300-400 billion. When this happens, I am sure the bulls of all bourses will take the cue.

Of interest to us is that the investment of even a part of the forex reserves of the Asian countries will mean higher prospects for bourses and corporates across the world. Even a part of China's trillion-dollar hoard, together with a part of the mini-China-like reserves, cannot be less than $100-200 billion.

This can make a tremendous impact on markets around the world. However, care has to be taken to see that this business does not translate into a hedge fund-led boom-and-bust phenomenon, such as the yen carry business did recently.

All this casts a heavy responsibility on the shoulders of regulators, both of stock markets and of banks, across the globe.

The news that abundant reserves will be invested in stock markets should spur them to much greater care and regulatory measures of increased sophistication to handle the likely manipulations of intermediaries, including insider investors.

Eternal vigilance is needed to handle the coming flood, which brings with it a cornucopia of risks that China's new initiative opens up.

The repercussions of China putting a part of its reserves into global stock markets can be quite significant. Agreed that, for one thing, they will help the bullish trend in markets boom around the world.

For another, the shift of large sums from the bond market in the US will lead to interest rates going higher as also to the dollar getting weaker.

The net effect of the transactions, taking into account both these effects, has to be watched before we reach any conclusion.

China's Century

Hopefully, China will not do anything that will depress the greenback overmuch as this will directly hit the value of its reserves, the bulk of which are invested in dollars.

Further, a weaker dollar means a stronger yuan, which will only hurt China's exports. But it must be granted that China's latest decision means there are exciting times ahead when China will be able to make the global markets and currencies dance to its tune much more than ever before. This will truly be China's century.

Incidentally, there is a piece of gratuitous advice to China from noted American economist Fred Bergstein last week in Financial Times, headlined "The yen beckons China". What he is suggesting is that China buys up yen using its hoard of dollars.

Incidentally, this move will help the US by appreciating the Japanese yen and lowering China's hoard of dollars. This is a self-serving counsel and both China and Japan need to beware of such comment coming from exalted quarters, mainly keeping the US' interests in mind.

Moving closer home, the time is ripe for India to examine the initiative China has taken. We have, of course, to be careful that India's new forex investment company, created in Temasek-style, does not become a "directed" investment arena.

An Ombudsman is needed to ensure that the investment company invests according to well-established criteria of profits and safety.

Obviously, in recent times, India has shown itself to be sophisticated enough when it comes to managing investment firms. UTI Mutual Fund is an example of Government controls without emasculation of the freedom of management.

Here is hoping that India's attempt to follow the Chinese initiative in setting up a Temasek-like organisation has better luck than the experience with the China-style SEZs. Much rides on the successful implementation of this new initiative.

A difference of 6 per cent plus returns on our reserves can mean upwards of Rs 40,000-50,000 crore a year extra returns — a sum not to be sneezed at in our present straitened fiscal circumstances.

The comrades cannot quarrel about it either. We can rightly claim that we are following Beijing's example.

This is one instance in which the Left would be right to cheer Mr Chidambaram in an initiative to spur the stock markets, not only in India but across the world. But are we hoping for the impossible to happen?

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