 "Why China’s forex reserve depletion of ‘only’ $100 bn can accelerate")
The only good news coming out of China this week is that its Chinese markets are closed and they will take a week to react to the fall in its foreign reserves news. For the third straight month in January, China reported a drop in its foreign reserves by $99.5 billion to $3.23 trillion, the lowest level since May 2012.
While the number might seem large, they are lower than consensus analyst estimates of a depletion of nearly $120 billion. This follows a $107.9 billion fall for the month of December 2015, its highest ever drop in reserves. China’s central bank has been active in the currency market since its devaluation in August 2015.
But China is not the only country using its reserves to ‘manage’ its currency and thus its economy. It has, however, not been able to manage its trade account too well. Exports from China have fallen for five straight months, while imports have dropped for 13 straight months.
Likewise, India’s central bank has been active in controlling the outflow of foreign institutional investors and keeps the rupee attractive enough to help exporters. But the global slowdown, which impacted Chinese exporters, is hurting Indian companies as well.
While China has been digging in its foreign currency reserves like India to keep its economy competitive in the global marketplace, others are using up their savings to meet their revenue shortfalls. Saudi Arabia and other oil-producing countries are encashing their savings to meet their fiscal deficit. Saudi Arabia is estimated to sell nearly $20 billion of their assets every month to meet 15% fiscal deficit.
Saudi Arabia with its $608 billion reserves and China’s $3.23 trillion reserves are the big sellers in the financial markets, be it equity or currency globally. It’s their selling that is causing high volatility worldwide. At the current rate of selling it might seem that both the countries might have three odd years of reserves. However, China’s condition seems to be more precarious than Saudi’s.
Apart for October, when China surprisingly reported an inflow, the country has seen its reserve go down in eight of the last nine months. Despite the numbers reported by the country, few believe their veracity.
According to a Forbes column, China has been reporting declines far smaller than consensus prediction since August 2015. The author quotes a Financial Times report saying that China’s central bank is counting its holding in Renminbi (CNH) held outside China’s currency boundary as part of the foreign exchange reserve.
China has two traded currencies, CNH and CNY, which refer to Yuan (RMB). CNH is a floating currency which is traded offshore, mainly in Hong Kong, while CNY is traded within China. The country has been buying Yuan in the offshore market in an attempt to narrow the gap between fixed Yuan (CNY) and floating Yuan (CNH) where it is selling its foreign currency holding.
The other reason cited is that China has been trading derivatives to hedge and mask its selling. When this position is rolled back China’s reserve position is expected to fall dramatically.
Further, China is restricting its capital outflows both by individuals as well as corporates, might have helped curb outflows to some extent. But historically, restriction have worked only for a short duration.
Liquidity, or rather the lack of it, is the result of the government’s measure of using its reserve to manage the currency. India too is facing its share of liquidity issues as the central bank uses its reserves to manage the rupee against foreign currencies. China however, has a bigger problem given the size of the outflow.
According to the Forbes columnist, though $3.23 trillion may sound like a large foreign exchange reserve, China’s reserves may already be below IMF’s safety line on account of some of its illiquid and sunk investments. Once this is formally declared, the real selling would start.
