China's FX reserves may stoke inflation, a big burden

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China's war chest of foreign currency reserves has become a headache as its continued rise could stoke inflation in the long term, Premier Li Keqiang said in remarks seen on Sunday, pledging to reduce the country's trade surplus.

China's foreign exchange reserves, the world's largest, grew by $130 billion in the first quarter, to a record $3.95 trillion.

The central bank has pledged to keep foreign exchange reserves at reasonable levels, partly by reducing its intervention in the currency market.

"Frankly speaking, foreign exchange reserves have become a big burden for us, because such reserves translate into the base money, which could affect inflation," Phoenix New Media Ltd quoted Li as saying during a visit to Kenya.

"From China's perspective, macroeconomic controls could face tremendous pressures if the overall trade is imbalanced."

China will take steps to reduce its trade surpluses with the rest of the world, including Kenya, Li was quoted as saying.

Large foreign currency purchases by China's central bank, which regularly intervenes to cap yuan rises, amount to creation of base money and can fuel inflation unless the central bank soaks up the excess yuan injected into the system.

In recent weeks, the central bank has been suspected of engineering a fall in the yuan CNY=CFXS in a bid to punish speculators betting on yuan rises.

Yi Gang, vice central bank governor, said in November that the cost of holding the reserves would surpass earnings from them when reserves exceed a certain level.

China's inflation has been benign in recent months as its economy slows, but analysts point to long-term pressures as the government loosens its grip on utility and resources prices.

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