JNN 10 Jan 2011 : China’s foreign exchange reserves jumped by a record $199bn in the last quarter of 2010, taking the total to $2,850bn and underlining the continuing imbalances in the global economy.

Already the largest in the world, China’s reserves increased by 18.7 per cent over the course of 2010, including an increase of $194bn in the third quarter.

Although China’s monthly trade surplus dropped in December, the continued strong increases in its foreign exchange reserves will bolster the case of critics who are calling for a more rapid appreciation of the renmenbi.

Currency and trade issues are likely to feature strongly when Hu Jintao makes a state visit to the US next week, amid renewed talk internationally about a “currency war’.

The continued increase in reserves is also complicating the management of monetary policy at a time when strong bank lending and a rising money supply are already adding to inflationary pressures in the economy.

Total new Rmb-denominated bank lending in 2010 hit Rmb7,950bn, overshooting the Rmb7,500bn target Beijing set at the start of the year, according to central bank figures released on Tuesday.

“China’s continued strong bank lending and massive reserve accumulation could be bellwethers of trouble to come,” said Eswar Prasad, former head of the IMF’s China division. “They throw cold water on the notion that macroeconomic policies have the economy under control and have struck the right balance in keeping growth high while preventing overheating.”

The central bank said the total stock of new loans in 2010 was Rmb1,650bn less than the amount issued in 2009, but some analysts believe the official figures understate the true scale of bank lending.

“Talk of a substantial slowdown in credit growth in China is premature, but understandable given the visible drop in official figures on net new loans,” said Charlene Chu, head of financial institution ratings at Fitch in China, in December. “However, in reality lending has not moderated, it has been diverted into other channels.”

Fitch argues Chinese Banks simply offloaded trillions of Rmb in loans from their balance sheets in 2010 by artificially reducing their holdings of discounted bills and by repackaging loans into investment products for sale to investors.

The headline figure for China’s reserves reflects the trade surplus, direct foreign investment and inflows of short-term capital, although it is also affected by the impact of exchange rate movements on the value of Chinese assets.

The central bank intervenes in the market by buying foreign exchange with Rmb in order to hold down the value of its currency and the foreign exchange that it buys ends up in its reserves.

It then has to sterilise much of the newly-issued Rmb by selling special bills to banks and requiring banks to hold more of their deposits on reserve with the central bank in order to manage liquidity in the Chinese economy.

China raised interest rates twice and increased the required reserve ratio six times last year as it gradually tightened monetary policy.

Although Chinese leaders have warned in recent months that the US Federal Reserve Policy of ” quantitative easing ” risked a flood of hot money coming into China, a senior official at the body which manages China’s reserves played down such fears earlier in the week.

“We did not find any organised or big-scale hot money inflows,” Liu Wei, a director at the State Administration on Foreign Exchange, said in an interview with a Chinese magazine. “Although we cannot rule out hot money flowing into China from abroad for carry trades, that is not usually the case and it is not proper to blindly overstate the scale of hot money.”