China: FX Reserve Reversal

Published on April 26, 2016

China’s FX reserves shrank by $117.783 billion in the first quarter of 2016. That marked the first time China has experienced seven consecutive quarterly drops in its reserves, the ninth quarterly net decline in its FX reserves history, and the country’s third largest quarterly reduction since 1998.

*** But underneath the quarterly FX reserve figures the trend has been one of dramatic improvement from the start of the year to March, a trend the People’s Bank of China expects to hold up through April and the second quarter of the year. In that first quarter FX reserve flows slowed from a drop of $99.469 in January to $28.572 in February, and turned to a positive add of $10.258 in March. ***

*** The PBoC expects that trend to continue and for FX reserves to continue to now accumulate at a modest pace as the country’s economy stabilizes, and with it, the RMB remains relatively stable against a basket of currencies, and especially against the USD. The PBoC forecasts that reserves could continue to increase by “several” billion dollars over the second quarter of 2016. ***

An Improving Trend

China’s quarterly reserve drop of $117.783 billion in Q1 of 2016, while significantly slower than the last two quarters, nevertheless marked an unprecedented seven quarters of declines, following a net reduction of $183.758 billion in Q4 of 2015, $179.718 billion in Q3, $36.2 billion in Q2, $112.98 billion in Q1, $44.682 billion in Q4 of 2014, and $105.513 billion in Q3 of 2014.

But within the first quarter the trend was unmistakably positive, reversing an almost 100 billion dollar monthly pace of declines in January to a modest 10 billion dollar add, and stabilizing FX reserve levels at $3.213 trillion, a couple of hundred billion dollars above the sensitive $3 trillion mark Chinese officials have been aiming and hoping will mark a floor on reserves.

PBoC officials believe the FX reserves performance in the first three months reflects the success of the central bank’s measures to stabilize the RMB that, combined with prospects for a stabilizing if not even improved outlook for China’s economy, have led to an easing of capital outflows.

They also point to the Federal Reserve’s decision to slow the pace of interest rate hikes for 2016 that has cushioned global economic conditions and financial market volatility, and caused a broad-based retreat in the USD (see SGH 4/20/16, “China: G20 Postscript on Fed, RMB, and Credit Downgrades”).

Beneath the Numbers

According to the latest report that the PBoC submitted to the State Council and the Central Financial Leading Group, the steadying of the RMB and the passage of the Chinese New Year holidays resulted in a diminishing demand for dollars in March.

Indeed, Chinese individuals purchased only $3.1 billion in March, significantly lower than the $7.2 billion of foreign currency they bought in February and the whopping $31.8 billion levels of January.

Chinese companies for their part purchased $10.4 billion in March to repay overseas dollar debt, also sharply lower than the $21.7 billion in February and $35.1 billion in January.

And roughly $4-$5 billion of hot money is estimated to have flown from the country in March, compared with estimates of $8-$9 billion in February and $18-$22 billion in January. Approximately $9.7 billion of reserves was allocated to national defense spending in March.

The foreign exchange settlement-sales deficit came in at $36.4 billion in March, compared with the $33.9 billion deficit recorded in February and the $54.4 billion seen in January. The data marks the ninth straight month of deficits.

The translation effect of currency rates also positively impacted the reserves data. Major currencies, especially the EUR and GBP, strengthened against the USD over the quarter, leading to a big paper gain of $27.1 billion in March, compared to a slim gain of $314 million in February and a decline of $10.24 billion in January.

Out of a total trade surplus of $29.9 billion in March, $18.5 billion was converted into RMB from USD, and about 60 percent of export and import companies are estimated to be converting their trade revenue into RMB. That situation is an improvement in comparison to the just $12.6 billion that was converted out of a total trade surplus of $31.9 billion in February, and far better than the $11.8 billion converted out of a total of $63.29 billion in January.

The PBoC report concludes that the March reserve figures show the pressure of cross-border capital outflows has eased significantly compared with the start of this year. Corroborating those figures, domestic commercial banks registered a total of $124.8 billion of net FX sales over the first quarter of 2016

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