China's $3 Trillion In Reserves Questioned After PBOC Reports $41 BIllion In December Outflows

In late December, ignoring the official Chinese monthly reserve data and instead using a dataset provided by China's FX regulator SAFE on cross-border RMB flows and on onshore FX settlements, Goldman calculated the true amount of Chinese FX outflows and found that Beijing has continued to mask the full extent of its capital flight, which in November spiked to $69 billion (well above the reported, currency adjusted number of $34 billion). Furthermore, it found that "since June, this data has continued to suggest significantly larger FX sales by the PBOC than is implied by FX reserve data."

Even more troubling, Goldman calculated that cumulatively since August 2015 through November 2016, FX outflow totaled roughly US$1.1 trillion, while implied FX sales suggested by PBOC’s FX position (headline reserves after adjusted for currency valuation effect) were approximately US$630bn (US$540bn), indicating that the real rate of reserve depletion was nearly double that represented by PBOC reserve data.

Exhibit 1: FX outflow picked up to US$69bn in November

Why would China try to misrepresent the full extent of its currency outflows?

Simple: it is an ongoing attempt by the PBOC to not precipitate the feedback loop of even further panicked selling of Yuan, even greater purchasing of Bitcoin, even more outflows, and thus, even more reserve depletion.

And while we have yet to obtain the December FX data from SAFE, overnight the PBOC reported that in December China's reserves fell a further $41.1 billion, exactly in line with expectations, reducing China's total reserves to $3.01 trillion, the lowest number in six years, and just fractionally above the $3 trillion cited by various analysts as the key support level below which any further capital outflow would become self-reinforcing. According to a statement by SAFE on Saturday, the December decline in FX reserves was mainly because the central bank supplied funds to maintain balance in the foreign exchange market and the depreciation of non-U.S. dollar currencies. For the full year of 2016, the SAFE said the central bank’s effort to stabilize the yuan was the key reason for the drop in reserves.

That said, when considering the discrepancy with SAFE data, it is likely that the true level of Chinese reserves is now well below $3 trillion, as a simple correlation with China's plunging Yuan demonstrates.

To be sure, China will likely take additional measures to keep its foreign-currency stockpile from slipping too far below the key $3 trillion mark - or whatever the real level of reserves is - to avoid further hurting investor confidence and spurring further declines in the yuan, according to economists at major banks cited by Bloomberg. As documented here over the past week, in a desperate last ditch measure to halt further outflows, since the New Year China rolled out draconian new FX capital controls as well as extra requirements for citizens converting yuan into other currencies after the annual $50,000 quota for individuals reset Jan. 1.

As a result, Yuan volatility exploded last week, with the offshore rate notching up its biggest two-day gain on record just days after completing its worst yearly performance against the dollar as a result of an unprecedented spike in overnight offshore Yuan deposit rates, which forced Yuan shorts to cover all exposure.


Still, according to Gao Yuwei, a researcher at the Bank of China’s Institute of International Finance in Beijing, policy makers now may prefer using capital controls instead of burning through foreign exchange reserves to defend the yuan. It remains to be seen how effective such capital controls will be in the long run as every previous iteration has failed to prevent ongoing capital flight.

“China’s government is well positioned to control outflows more effectively if it wants to, though it may not want to be seen as reversing China’s ‘opening’ strategy,” Wang Tao, head of China economic research at UBS, wrote in a recent note. “In the long run, it may not have much choice if FX reserves fall more sharply on the back of intensifying capital outflow pressures.”

A key question facing China now is whether it has enough reserves. In Tao's note, the UBS analysts said that China does have more than enough FX reserves to cover import bills and foreign debt payment...

As of November 2016, China's official FX reserves stood at $3.05 trillion, down from $3.84 trillion at end-2014. At this level however, they are still 3.5x China's total non-RMB foreign debt, 6x its short-term external obligations, and can cover over 20 months of goods and services imports (minimum requirement is 3 months). The official FX reserves do not include the $110 billion "other foreign currency assets" on PBC balance sheets, long-term foreign assets held by China Investment Corporation and State Administration of Foreign Exchange's corporate subsidiaries, or FX reserves used for recapitalizing policy banks. Don't forget that China still has an annual current account surplus exceeding $200 billion too.

... but not enough for long-term currency defense, even if its disclosed reserves are accurate, liquid and usable:

Most FX reserves are liquid and useable, but not for defending the currency over a long time. We estimate that about 60% of China's FX reserves are held in USD assets (Figure 7), of which about $1.1 trillion is directly invested in US treasuries and the rest in corporate bonds, agency debt and equity. Another $500 billion is estimated to be in developed market government bonds.

UBS also notes that the IMF estimated in 2016 that to withstand a currency attack, China would need between $1.75 trillion (with capital controls) and $2.82 trillion (no capital controls), using its composite metric for FX reserve adequacy as of end-2015. Given that China has some capital controls, its "adequate" reserves level may be somewhere in between. However, if the PBC uses FX reserves to defend the exchange rate for too long, the gradual decline of its reserves may erode confidence.

In short: it's anyone guess i) what the real level of China's true, usable reserves is currently (most likely well below $3.0 trillion), and ii) whether that will be sufficient to wake a prolonged currency attack, both from outside, speculative sources, and continued outflows predicated by Chinese savers seeking to park their cash offshore.

Aside from its dollar reserve, China also reported that the value of its official gold holdings dropped to $67.9 billion by the end of December, down from $69.8 billion a month earlier, as a result of the drop in the price of gold. The nation kept gold reserves unchanged at 59.24 million troy ounces for a second month in December, the first time it disclosed a halt in gold purchases for two consecutive months since disclosing holdings as of June 2015. Just like with its misrepresentation of its reserve outflows, many analysts are skeptical that China reveals the truth about its gold holdings.