Insurance Reserves

Insurance Reserves

October 2, 2005

Two Monday’s ago China’s government announced that for the first time domestic insurance companies would be allowed to invest their foreign exchange assets abroad in foreign securitites including stocks. These principally occur when a domestic Chinese company undertakes a joint venture with, say, an American company, to expand operations in China. If the US company contributres $100 million to the venture in the form of dollars, for example, the joint venture will no longer be required to convert the sum into RMB and invest it in China. They can turn around and buy shares in the US market.

At first blush, this looks like a simple cast of getting the jump on the WTO requirement to open capital markets by the end of next year. Indeed, we can think of it as mini-convertibility or a partial relaxation of capital controls. I am completely convinced the Chinese government will do whatever it takes to satisfy the requirements in advance of the Beijing Olympics.

There is a second way to interpret the change. Before, the insurance company would have sold the dollars, which would have been subsequently purchased by the central bank. Now they will be held on the insurance company balance sheet as dollar assets. The net result will be to reduce central bank dollar asset holdings by $100 million, the number that US policymakers watch with great interest. ($740 billion in august.) It will look like they are buying fewer dollar assets but there will be no resulting pressure on the currency.

Pretty clever.

This supports the view that the announcement in July to revalue the RMB was more political window-dressing than real. I hope that is the case. The US policy was a terrible mistake. A stable RMB/$ exchange rate is very important for maintaining steady growth and stability there.

JR

John Rutledge

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