China’s foreign exchange reserves, already the world’s biggest, soared again in the second quarter, adding to inflationary pressure and highlighting the risks in Beijing’s policy of holding down the value of its currency.

Reserves are a key indicator of central bank intervention in the currency market because they reflect how much foreign exchange it has purchased in order to stabilise the renminbi. After jumping $197bn in the first quarter, reserves were up another $153bn in the second quarter.

That influx of cash compounds China’s inflation troubles. Consumer prices were up 6.4 per cent in the year to June, the highest in three years. Although many analysts expect inflation to slow over the remainder of the year, the accumulation of reserves lays the groundwork for a continuation of fast money growth and so will limit the scope for any easing of price pressures.

“The current intervention of the People’s Bank of China has been piling up more and more foreign exchange reserves. This is not sustainable,” said Li-Gang Liu, head of China economics at ANZ Bank.

A mild rebound in money growth in June illustrated that China remains flush with cash, even after a succession of interest rate increases and other moves by the central bank to restrict bank lending. The broad M2 measure of money growth was up 15.9 per cent year on year in June, accelerating from 15.1 per cent a month earlier.

China raised interest rates last week for the fifth time in eight months. Economists are now debating whether Beijing will raise rates again this year to damp down inflation or desist from further tightening amid signs of a growth slowdown.

Premier Wen Jiabao said on Tuesday that policy makers needed to tread carefully.

“We must slow price increase, but we also must avoid causing big fluctuations in growth,” he said in a statement after meeting officials and business leaders.

A stronger renminbi also has a crucial role to play in easing inflation, as it would reduce the cost of imports and, more importantly, restrain money growth by adding less to foreign exchange reserves.

Nevertheless, despite repeated pledges by China to make its exchange rate more flexible, the renminbi has climbed just 2 per cent against the dollar this year and has actually fallen against a basket of currencies of its main trading partners. That sluggish performance and concerns about China’s slowdown have led traders to scale back bets on renminbi appreciation.

China’s total foreign exchange reserves stand at $3,197bn, equivalent to about 50 per cent of gross domestic product and almost three times more than any other nation’s reserves.

Nearly $47bn of the $153bn second-quarter increase came from China’s trade surplus, with investment inflows and interest earnings accounting for much of the rest.

China must print renminbi to buy all the foreign exchange streaming into the country. To blunt the inflationary impact, it issues bonds and orders banks to set aside a chunk of their deposits as required reserves, but economists say that room for such “sterilisation” operations is increasingly limited. That could put currency appreciation back to the forefront of efforts to damp down on inflation.

“Unlike recent market sentiment, we think that the renminbi will have to appreciate faster in the second half of the year,” Mr Liu said, forecasting the currency would gain 3-4 per cent against the dollar.

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