BEIJING, July 15 -- China's foreign exchange reserves increased by just over US$100bn in the first six months of this year to US$711bn, nearly double the rate at which its store of overseas currency rose in the same period last year.

    China's foreign reserves are on track to break US$1,000bn by June next year if they continue to expand at the current rate, according to Stephen Green, an economist with Standard Chartered in Shanghai.

    The build-up in reserves increases the pressure on the People's Bank of China, the central bank, and its efforts to control monetary supply and inflation, and will fuel an already intense debate about whether Beijing should revalue its currency, the renminbi, now pegged to the US dollar.

    The rapid build-up of foreign reserves in recent months has been driven primarily by a swelling trade surplus and strong foreign investment.

    Speculative capital inflows, much of it banking on a revaluation of the Chinese currency, are also contributing to the build-up, but not to the extent that they were late last year.

    "Hot-money inflows appear to be easing," said Ben Simpfendorfer, an economist with JP Morgan.

    Mr Simpfendorfer said that so-called hot money accounted for US$11bn of the increases in reserves in the second quarter of this year, compared with a US$53bn inflow in the fourth quarter of 2004 at their peak.

    The central bank conducts extensive money market operations to minimise the impact of capital inflows, issuing bills to drain liquidity from the system to ensure that it keeps in check the amount of money in circulation, a key driver of inflation.

    The bank's operations, aimed at sterilising the impact of capital inflows, have been made easier by a growing gap in interest rates between China and the US.

    China issues banks bills at home to drain the extra cash out of the banking system, while it puts substantial amounts of its foreign currency holdings in US Treasuries, which offer higher interest rates, making sterilisation for the moment profitable.

    But Mr Green says that the value of the PBoC's outstanding bills is now equal to 12.5 per cent of GDP. "This increases the risks to the PBoC, particularly in the event of (Chinese) rates rising," he said.

    (Source: Financial Times.com)