Author: Fan Gang, President of CDI

Editor’s Note: “The decline in China's foreign reserves is good news in the long-run,” said Prof. Fan Gang, the President of CDI, in an interview with Bloomberg Television in Shanghai on January 9, 2017.

The decline in China's foreign reserves is good news in the long-run,” said Prof. Fan Gang, the President of CDI, in an interview with Bloomberg Television in Shanghai on January 9, 2017.

Much of the yuan that’s been converted into dollars hasn’t left the country, but shifted from official holdings to the private sector, according to Fan. Large foreign currency holdings by the government are deemed as less efficient. To improve efficiency, banks can use those funds to invest in higher-return assets.

China's reserves shrank by $41 billion to a fresh five-year low of $3.011 trillion in December 2016, posting the sixth straight month of declines. Capital flight has accompanied yuan’s steepest annual drop in more than two decades.

The government's moves to restrict capital outflows, which have fuelled depreciation in the yuan, are to prevent rapid fluctuations in reserves. Fan said that no government likes to see rapid changes in its foreign reserves. Instead, it prefers to see incremental changes over time. What’s more, he also said that yuan was overvalued for the last three or four years and this should be corrected.

Chinese policy makers’ intensified efforts to stem capital outflows have been effective and the market has started to respond. According to Fan, while China will not totally drop capital control measures yet, it is unlikely that they will step them up.

The inclusion of yuan in the SDR basket has made it an international currency, which means China needs to hold less foreign reserves for the purpose of international credit. “We have been talking about the inefficiency of $4 trillion in foreign reserves and the ridiculousness of a developing country financing a developed country,” Fan said.