Chinese Reserves Unexpectedly Drop Below $3 Trillion For The First Time Since 2011

Beijing surprised China-watchers this morning, when the PBOC announced that in January, China’s foreign-currency reserves dipped by $12.3 billion, below the key "psychological level" of $3 trillion, or $2.998 trillion to be exact, declining for the 7th consecutive month, and dropping to the lowest since early 2011. Consensus had expected a drop of $10.5 billion to just above $3 trillion.

According to the PBOC, holdings of SDRs decreased to 2.21 trillion from 2.24 trillion in December. Gold reserves remained at 59.24mm troy ounces, however rose in dollar terms due to the increase in the price of gold from $67.9BN to $71.3BN.

The central bank’s intervention in foreign-exchange markets drove the drop, as did seasonal factors such as high demand for other currencies during the week-long Lunar New Year holiday, the State Administration of Foreign Exchange said in a statement.

The January decline was much smaller than the $41 billion reported in December, and was the smallest in seven months, indicating China's renewed crackdown on outflows appears to be working, at least for now. China has taken a raft of steps in recent months to make it harder to move money out of the country and reassert a firmer grip on its faltering currency, even as U.S. President Donald Trump steps up accusations that Beijing is keeping the yuan too cheap.

While the $3 trillion mark is not seen as a firm "line in the sand" for Beijing, concerns are swirling over the speed at which the country is depleting its reserves and how much longer it can afford to defend the currency. Some analysts estimate China needs to retain a minimum of $2.6 trillion to $2.8 trillion under the International Monetary Fund's (IMF's) adequacy measures, and fears of a devaluation would likely intensify capital flight.

The drop in January's reserves could have been worse if not for a sudden reversal in the surging U.S. dollar in January, some analysts said. The softer dollar boosted the value of non-dollar currencies that Beijing holds. The yuan has gained nearly 1 percent against the dollar so far this year. But analysts expect downward pressure on the yuan to resume, especially if the U.S. continues to raise interest rates, which would likely trigger fresh capital outflows from emerging economies such as China and test its enhanced capital controls.

As Bloomberg adds, further erosion of the world’s largest stockpile may prompt policy makers again to tighten measures for controlling outflows and on companies transferring money to other countries. Authorities recently rolled out stricter requirements for citizens converting yuan into foreign currencies as the annual $50,000 foreign exchange quota for individuals reset Jan. 1.

Some analysts fear a heavy and sustained drain on reserves could prompt Beijing to devalue the yuan as it did in 2015, which would sow turmoil in global financial markets and likely stoke political tensions with the new U.S. administration.

Economists expect more forceful tightening of regulatory controls after Tuesday's data, though China's financial system is notoriously porous, with speculators quickly able to find new channels to get funds out of the country. Here are some thoughts from the economist community:

  • "With FX reserves below $3 trillion, we can expect capital controls as well as tightening yuan liquidity to continue, as the authorities try to avoid a further drawdown," said Chester Liaw, an economist at Forecast Pte Ltd in Singapore, referring the central bank's surprise hike in short-term interest rates on Friday.
  • “With reserves dropping below the psychologically important threshold of $3 trillion, this will further ramp up pressure on Chinese policy makers to prevent the further draining of reserves," said Rajiv Biswas, Asia-Pacific chief economist at IHS Global Insight in Singapore. "The Chinese government and the PBOC are now facing a tremendous battle to stem further significant capital outflows while also trying to maintain confidence in the yuan."
  • "A combination of yuan strength, stricter capital controls and substantial valuation effects failed to arrest the slide," Tom Orlik, chief Asia economist at Bloomberg Intelligence in Beijing, wrote in a report. "A seventh straight month of falling reserves, and a drop below the $3 trillion threshold, means no respite for China’s policy makers in their battle against capital outflows."
  • "The PBOC isn’t defending the $3 trillion threshold at all costs, as some thought," said Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc. in Singapore. "Reserves have showed signs of stabilization, and the momentum will continue."
  • "The breach of $3 trillion isn’t significant in the big picture," said Jason Daw, head of emerging-market currency strategy in Singapore at Societe Generale SA. "It was only slightly lower than consensus and inevitable given the trend over the past couple of years."


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