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China's foreign exchange reserves look set to hit the US$1 trillion mark at the end of this month or beginning of November. But as the figure rises, so does the debate over how to best manage it.

The reserves, already the world's biggest, surged to US$987.9 billion at the end of September, largely driven by a burgeoning foreign trade surplus and massive inflow of foreign direct investment (FDI).

In the first nine months of the year FDI stood at US$42.59 billion, although this was a 1.52 per cent drop year-on-year.

Reserves grew on average US$18.8 billion each month from January to September, statistics from the central bank show.

"How to manage such a huge reserve is a big challenge," said Yi Xianrong, a research fellow at the Institute of Finance Research under the Chinese Academy of Social Science.
"The crux of the problem is that you have to keep the value stable or increasing," Yi said.

The ballooning foreign reserves, many economist say, is a major reason behind the loose money supply. This is because the central bank has to issue additional money to mop up the excess US dollars in the market, resulting in excessive liquidity in the banking system.

And the fluctuating foreign exchange rate also poses a huge risk, economists say.

In a bid to minimize such risks, the central bank should diversify its existing US dollar-dominated foreign reserves structure, and increase its holdings of euros or other major international currencies, said Li Yongsen, a finance professor at Renmin University of China.

The central bank, he said, could also buy more state bonds issued by other major economies and decrease holdings of US Treasury bills.

"It's better to spread the risks, and not put all your eggs in one basket," Li said.
The professor also suggested that the country might consider using the huge foreign reserves to purchase some strategic resource reserves such as oil.

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