Estimation And Major Affecting Factors Analysis On Optimal Scale Of Foreign Reserve In China

An optimal scale of foreign reserve (FR) could successfully achieve the goal of steady and continuous economy growth, balance the international payment, and also stabilize the exchange rate. For quite some time, not only the international financial setup and governments of different countries but also the economists pay great attention to the management of foreign reserve, especially the problem of its optimal scale. Since 1994, the structural reform of exchange management, the scale of foreign reserve increased promptly. By the end of 2006, the remaining sum of China's FR went beyond 1 trillion dollars, which make China the first place among the big powers. So, it is of momentous current significance for the currency authorities and government to determine a reasonable and optimal level of FR in order to get good control of it.In this paper, we established models for the optimal scale of FR in China with consulting to relevant researches on FR demands and its optimal scale. After estimating the optima level of FR in China by cointegration methods, we analyzed the misalignment of FR scale in China and finally we put forward the suggestions for the management of FR in China.Firstly, we reviewed the literature concerning this very topic and found the current researches mainly focused on different angles: for instance, the regression analysis based on payment of export,repayment of debt and such factors; There was also the way to study from certain demands, such as reserve/import and debt/reserve kind of ratio methods; J.Agaual's opportunity cost theory took developing countries into account. They all had their unique superiorities, but every coin has two sides. For the sake of diverse economy structures and development gap, we have to consider different factors of each country to measure its proper FR scale. And looking back to the domestic research, we noticed the main trend of study focuses on the factor analysis, a evolution form Frenckel's demand model, which set up regression models with important factors. This is also this paper's theoretical basis. Before the empirical research, we explained major concepts with regards to the FR; this could give us a clear understanding of the object of study and great significance. Afterwards, we introduced the historical and current situations of FR in China, which helped to know better about the background of study. And next, we analyze the influencing factors of FR from both the demand and require sidesAs for methodology, this paper is based on the research of Frenkel, improved his regression model, which makes it more suitable for our actual circumstance, and we estimated the relationship among all the variables. The paper set out from the experiences in and out the country, analyzed some mainly factors. We chose four typical macro-economic variables: FDI (Foreign Direct Investment),GDP (Gross Domestic Product),IM (Import) and EX (Export), which all satisfy the condition of I(1). We use the four variables in the Granger test and conclude that GDP,FDI,IM and EX can affect the FR scale of China in the sense of the Granger test. Therefore, it is essential to analyze the influence to the FR in China by the four variables. According to the work done before, we establish the cointegration model between the optimal scale of FR and macro-economic variables. Listed as follows:LFRSA=α₁+α₂LGDPSA+α₃LFDISA+α₄LIMSA+α₅LEXSA +εBy estimating the cointegration model, we have obtained the same conclusions as beforehand analysis, that the rapid development of economy and increase of export may cause the rise of optimal FR; on the other hand, the expansion of import and increase of inverse flow of FDI may lead to the decline of optimal FR.Due to the cointegration relationship between the optimal FR and macro-economy variables, there is to be an error correction model (ECM) which depicts the adjustment from short fluctuation to long-term equilibrium. After estimate the ECM, we got a self-revised and long-term equilibrium model. Based on the it, we built the Impulse-Response equation and got the charm, which shows that the responds of FR to GDP and EX are both positive, but as to FDI and IM are both negative. And we came in to the conclusion that all the impulses from macro-economy variables to FR are stabilized and smooth in a long run.In the following paper, we estimated the optimal scale of FR and compared it with the actual scale. We arrived at the conclusion that the actual scale of FR in China fluctuated in a small scope around the optimal level, which inferred the actual scale of FR was in accordance with the macro-economy variables. And although the actual scale of FR exceeded the optimal amount, which is excessive, it is inclined to the optimal level over a long period of time, and is adaptable to the economy development. Next, we reckoned up the misalignment of FR from 1985 to 2006 in China by using the Hodrick-Prscott filter. The paper gave explicit explanations of the misalignment according to the time sections, and obtained the reason for the excessive and insufficient of FR.In the last part, we put forward the policy suggestions for FR management in China on the basis of empirical analysis. After the research we have done in this paper, we found that the scale of FR is closely related to the macro-economy variables, therefore to stabilize macro-economy is an essential prerequisite for FR management; secondly, establish the risk management system of FR, to get prepare for latent danger is the guarantee and key link in FR management; thirdly, the appropriate adjustment of foreign trade and capital policy is the important way of FR management; finally, make rational use of the FR, wisely invest in other market and cut the cost are the higher requirement of FR management.