What Is the Extent of Monetary Sterilisation in China?

China is the world’s largest international holder, having amassed about US$ 2 trillion of international reserves by the end of 2008 (Figure 1.1), rising to US$ 3 trillion by 2010.1 The rapid accumulation of reserves by China has generated several controversies. One concern is whether this continuing balance of payments (BOP) surplus signals the need for a substantial revaluation or appreciation of the Chinese Yuan (CNY) to protect China both from the inflationary consequences of the liquidity buildup and a misallocation of resources2 as well as to help ease global imbalances. An alternative view, particularly associated with McKinnon and Schnabl (2003a,b; 2004), argues that a fixed exchange rate is an optimal policy for China and the larger Asian region both on the grounds of macroeconomic stability and rapid economic development. The global monetarist approach of McKinnon is based on the assumption of little or no sterilisation of reserve accumulation, so that any BOP imbalance is temporary. However, many other commentators have suggested that the Chinese government’s concern with inflation has led the People’s Bank of China (PBC) to heavily sterilise these reserve inflows.3