Reconsiderations on Foreign Exchange Reserves "Leading for Twenty Years"

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IMI Financial Observation

Introduction

In February 2006, China’s foreign exchange reserves reached $853.6 billion, surpassing Japan to become the world’s largest holder of foreign exchange reserves. Since the 14th Five-Year Plan, China’s foreign exchange reserves have remained stable above $3 trillion, maintaining the world’s number one position for twenty consecutive years. This has played a “ballast” role in stabilizing market confidence and serving the real economy. This article reviews the scale, structure, proportion of official reserve assets, and cost-benefit analysis of China’s foreign exchange reserves, and further discusses the evolution of reserve functions, optimal scale, and management models.

01

Research Background

(1) Sources of Foreign Exchange Reserve Accumulation and Scale Evolution

According to the International Monetary Fund (IMF), foreign exchange reserves are external assets controlled and readily available to the monetary authorities, including currencies, bank deposits, securities, equity securities, etc., mainly used to directly offset balance of payments imbalances or indirectly regulate them through interventions in the foreign exchange market.

In the balance of payments, increases in foreign exchange reserves mainly come from current account surpluses (trade in goods and services), capital and financial account surpluses (capital inflows). Some countries with deficits also form reserves by issuing foreign currency bonds directly. Since the reform of China’s foreign exchange system in 1994, continuous current and capital account surpluses have been the main reason for rapid growth in reserves.

Figure 1. Sources of China’s foreign exchange reserves

After joining the WTO, driven by persistent current and capital account surpluses, China’s foreign exchange reserves grew rapidly. By the end of February 2006, reserves reached $853.6 billion, surpassing Japan. In June 2014, reserves hit a record high of $3.99 trillion, over 180 times larger than in 1994 and nearly 2.4 million times larger than at the end of 1978. In 2015, due to RMB exchange rate reform and international environment changes such as the US tapering QE, the RMB faced significant depreciation pressure. The central bank used reserves to prevent a sharp devaluation, causing reserves to decline sharply in the short term, sparking debates on defending the exchange rate or reserves. From another perspective, the large short-term use of reserves stabilized the RMB exchange rate, avoided systemic macroeconomic risks from external shocks, and expanded the exchange rate flexibility. Since then, China’s reserves have remained above $3 trillion.

Data source: choice

(2) Asset Structure: From Dependence on a Single Asset to Diversification

The main component of China’s foreign exchange reserves is USD assets, primarily US Treasury bonds and agency bonds. Therefore, fluctuations in US bond prices significantly impact China’s reserves. Meanwhile, since reserves are denominated in USD, exchange rate movements greatly influence the conversion of non-USD reserves into USD-denominated assets.

Data source: choice

From a global perspective, according to IMF data from September 2025, the share of USD in international reserves dropped to 56.3% during Q2, a 30-year low. IMF researchers Glen Kwende, Erin Nephew, and Carlos Sanchez-Munoz noted in their report that “exchange rate effects caused almost all of the decline in USD share in reserves” in Q2, estimating that about 92% of the decline was due to exchange rate factors. Additionally, US tariffs, Fed rate cuts, and the US fiscal deficit pressures from the “Build Back Better” plan are important reasons. Long-term, the declining USD share is closely related to geopolitical risks and the weaponization of dollar dominance.

Figure 4. Global foreign exchange reserves: USD share (%)

Data source: IMF, Choice

In the context of weakening USD credit, rising geopolitical risks, and de-dollarization trends worldwide, China actively optimizes its reserve structure to strengthen financial security, enhance international monetary discourse, and serve long-term national development strategies.

China (billion USD)

Data source: Choice

China’s official reserve asset structure is becoming more diversified. The proportion of traditional core assets like foreign exchange reserves has slightly declined, while gold reserves have steadily increased. As of January 2026, China’s gold reserves have increased for 15 consecutive months. This change results from proactive reserve structure optimization and reduced dependence on single-currency assets, as well as macroeconomic factors like balanced balance of payments and reduced passive accumulation pressure. Gold reserves serve as a hedge against USD credit risk, enhance resilience, and support RMB internationalization with solid credit backing.

Data source: choice

(3) Cost-Benefit: The Dual Considerations of Holding Large Reserves

On the cost side, estimates show that from 2001 to 2011, China’s average annual opportunity cost of reserves was $114 billion, about 2.60% of GDP, rising to $315 billion (4.33% of GDP) in 2011. The offsetting costs for the central bank (weighted average interest on bills and reserve deposits) increased from 0.93% in 2002 to 2.57% in 2008, then decreased to 1.57% during 2009-2011. From 2003 to 2011, total interest paid for issuing bills, repos, and increasing reserve deposits was about 1.4-1.5 trillion yuan, accounting for 3.0%-3.2% of GDP in 2011. On the return side, data from the State Administration of Foreign Exchange shows average yields of 3.68% (2005-2014), 3.55% (2006-2015), and 3.42% (2007-2016). Estimates indicate that from 2018 to 2021, China’s foreign investment returns averaged 3.14%, maintaining a good level.

02

Reconsidering the Scale of Foreign Exchange Reserves

(1) Functional Demand of Reserves: From Transaction to Prevention

Former PBOC Governor Yi Gang pointed out that reserves are meant to be used, not just accumulated.

Existing research on factors influencing reserves mainly from demand-side perspectives, forming three main theories: transactional, precautionary, and mercantilist demands. Transactional demand is for importing needs and smoothing current account imbalances. Since the 1990s, with financial globalization and the Southeast Asian financial crisis, precautionary demand has gained attention, mainly to prevent sudden stops of capital inflows or capital flight, smoothing capital account imbalances. Deepening international trade has led to mercantilist demand, i.e., foreign exchange needed to promote exports and prevent currency appreciation. Post-financial crisis, rising global uncertainty has altered reserve structures, with high-liquidity reserves declining and gold increasing. Russell Mei et al. also proposed that reserve demand has dynamic substitution effects.

Figure 8. Dynamic evolution of China’s reserve demand (structure/structure)

(2) Optimal Scale: From Single Indicator to Multi-Dimensional Consideration

While China’s ample reserves have played an irreplaceable role in maintaining balance, resisting risks, stabilizing exchange rates, and enhancing credibility, more reserves are not always better. Holding large reserves incurs costs. Much of China’s reserves are in foreign government bonds, which offer low yields and can depreciate in value due to currency devaluation, facing market risks and opportunity costs, exerting pressure on market value and purchasing power. Additionally, the central bank’s passive monetary expansion to offset reserves can increase inflation and complicate monetary policy. Therefore, maintaining a reasonable reserve scale is crucial.

What is the appropriate scale?

Early research by Keynes introduced external economic factors into reserve demand analysis, emphasizing the importance of depletion risk, trade structure, and volatility. In the late 1960s, economists like Heller and Agarwal proposed the cost-benefit approach, suggesting the optimal reserve size is where marginal cost equals marginal benefit. This method was widely used for developing countries but overlooked policy adjustments and reserve financing alternatives, as well as long-term capital flows.

Russell Mei et al. summarized three views: insufficient, moderate, and excessive reserves. Some scholars argued that China’s reserves were insufficient, mainly during periods of low holdings. Others believed that current reserves are within a moderate, acceptable range, considering financial security needs. The excessive reserves view holds that China’s reserves significantly exceed the reasonable level, potentially harming economic development, though some suggest using sovereign wealth funds for hedging. Based on reserve types, some argue that China’s reserves are overly high and should be optimized, with a view toward sustainability and alignment with national strategies. Empirical studies suggest that a reserve-to-GDP ratio above 11.49% is considered appropriate for emerging markets.

(3) Large Reserves and RMB Internationalization

Some scholars believe that rapid reserve growth and holding the world’s largest reserves have promoted China’s economic development, enhanced national strength and influence, and created favorable conditions for RMB internationalization. Others argue that excessive reserves may hinder the internationalization of the RMB.

Promotion or Obstruction?

Some scholars point out that the impact of reserve size on currency internationalization is twofold. Zhuang Guoping et al. divided currencies into pre- and post-internationalization phases, finding that reserves promote RMB internationalization early on but may hinder it later. Li Yanli et al. found a nonlinear relationship, with an optimal reserve scale; beyond that, larger reserves could impede RMB internationalization.

From a strategic perspective, maintaining sizable reserves is necessary to withstand external shocks, especially amid rising anti-globalization and protectionism. As RMB internationalization advances, a moderate to high reserve level supports its process. When RMB fully functions as a trading, settlement, and reserve currency with large circulation, gradually reducing reserves becomes necessary. Excess reserves’ role diminishes, and the costs and risks of management increase. Rational reduction of reserves is advisable.

03

High-Quality Development Path for Reserve Management

(1) International Comparison of Management Models

Developed countries like the US and Europe hold relatively low reserves, mainly comprising gold, SDRs, and IMF positions, primarily for market stabilization. Their central banks are highly independent; reserve management is often handled by finance ministries to maintain policy independence. The US Treasury and Federal Reserve each hold about half of the US reserves, with the Treasury managing intervention funds and the Fed overseeing open market operations. The UK Treasury sets management policies, with the Bank of England executing them. The Eurozone lacks a unified fiscal authority, so the European Central Bank manages reserves. Japan holds significant reserves conservatively, mainly in low-risk government bonds, with policy driven by the Ministry of Finance, which manages reserves via special accounts.

Emerging markets, with excess reserves accumulated under global imbalances, pursue higher investment returns. They often establish specialized institutions for layered management, aiming for reserve appreciation and policy goals. Korea manages reserves across liquidity, investment, and trust segments; Singapore’s reserves are managed by MAS, GIC, and Temasek.

Resource-exporting countries, with simpler economic structures, focus on value appreciation, often through sovereign wealth funds. Management can be autonomous or delegated. Russia, a typical resource exporter, manages reserves jointly by the Ministry of Finance and the Central Bank, with the latter handling exchange rate interventions and the former managing value preservation. Reserves stabilize the ruble and provide funds during oil price drops but do not solve structural issues.

These international experiences suggest that reserve management should be tailored to national conditions and development stages. China should learn from layered and specialized management, emphasizing marketization, diversification, and green development, forging a unique path suited to its financial security needs.

(2) Maintain “Flexible” and “Well-Managed” Approach

Implement diversified, market-based investments, continuously enhancing investment capabilities. China’s reserve management aims for safety, liquidity, and value appreciation, leveraging risk-return characteristics of different currencies and assets to build a diversified portfolio. It explores investment benchmarks, establishing professional management systems. Additionally, sustainable investments, such as green bonds, are promoted as long-term goals, expanding green and sustainable investment scope. Over the years, China’s reserve investment management has improved significantly, ranking among the world’s best, effectively safeguarding assets’ safety, liquidity, and value.

Expand diversified use of reserves to serve national foreign strategies. Adhere to commercial principles, innovate channels and methods, and establish funds like the Silk Road Fund, China-Latin America Capacity Cooperation Investment Fund, and China-Africa Capacity Cooperation Fund. Currently, reserve utilization covers equity, debt, funds, and multilateral development financing, supporting national strategies at multiple levels.

Advance efficient, digitalized management systems, creating high-level operational service mechanisms. Since the 1990s, teams have built global operations platforms, establishing offices in Singapore, Hong Kong, London, New York, Frankfurt, etc., enabling 24/7 operations and enhancing cross-time and cross-market investment capabilities. Use information technology to improve efficiency, strengthen R&D, optimize systems, and build comprehensive digital management, significantly improving operational processes.

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Topic: International Finance and RMB Internationalization Group

Author: Sun Jiaqing

Supervisors: An Ran

Page Editor: Kong Shutong

Responsible Editors: Yan Yizhou, Li Jinxuan

Chief Editor: Zhu Shuangshuang