China: Reserves, Treasuries and Yuan

Published on January 14, 2021

China’s foreign exchange reserves rose by $38.032 billion, or 1.2%, in December of 2020, standing at $3.216522 trillion by the close of the 2020 calendar year and marking the highest level for China’s FX reserves since April of 2016.

Regarding the USD portion of China’s FX reserves, data from the PBoC show that USD assets increased by $12.303 billion through the course of 2020, Euro assets by $58.414 billion, and other majors by $33.27 billion, out of a total of $108.6 billion.

** While that annual pace of dollar reserve expansion may seem modest, it includes a major dip in Q1 of 2020, and senior sources stress that the portion of USD assets in China’s reserves is still too large, and that China will continue to seek to reduce its holdings of USD assets through 2021 as part of a broader, long-term diversification strategy (see also SGH 12/17/2020; “China: RMB and Dollar Reserve Concerns”).

** On a near-term political level, Beijing is hoping, but not operating under the assumption, that relations with the US will improve under the incoming administration of President-elect Joe Biden. With that as a backdrop, and with a wary eye on the strengthening Yuan, officials see no political gain in actively selling US Treasuries.

** Our understanding, however, is that Premier Li Keqiang has given the green light to a more measured, but still steady, disinvestment policy directive of “not renewing investments” when US Treasuries mature.

Reserve Growth and the Yuan

Breaking down 2020, China’s net FX reserve increase of $108.6 billion, or 3.5%, for the year came despite a sharp drop of $47.3 billion during Covid-ravaged Q1, which turned to a net add of $51.7 in Q2, $30.2 billion in Q3, and ended the year at the sharply higher pace of $74.0 billion for Q4.

To put those numbers in context, the $108 billion total for 2020, including the drag of Q1, compares to a net increase in FX reserve levels of $35.2 billion for all of 2019, and a net decrease of $67.2 billion for 2018.

The People’s Bank of China attributes the soaring 2020 reserve levels mostly to the fall in the dollar against major currencies, and to a rise in global asset prices. For December, it estimates that $21.1 billion of the $38.0 billion increase was attributable to foreign exchange translation effects, and about $17.5 billion to rising asset prices.

But the combination of inflows, a global weakening US dollar trend, and policies focused on domestic consumption over export growth has of course also put major appreciation pressure on the Chinese renminbi, with the RMB central parity rate against the USD rising by 4,315 basis points, or 6.5%, against the USD through 2020, from 6.9762 to 6.5249.

Tempering a Strengthening Yuan

Chinese officials were successful in halting that trend and putting a floor under the weakening currency at the 6.5000 level against the USD through all of December. But the buying floodgates were opened again on January 1, at least momentarily, leading to another sharp spike in the new year (see SGH 12/10/2020; “China: Sensitivity Around 6.50 RMB”).

For 2021, the PBoC expects robust capital inflows to support a “relatively strong” RMB, but officials predict the currency will hold steady against the USD through the course of the year. They vow that the central bank will do its best to dampen expectations of a one-way appreciation trend, allow greater two-way fluctuations in the RMB, and prevent the currency from “overshooting.”

PBoC officials point to two measures that were adopted since December to prevent excessive or rapid appreciation of the currency. On January 7, 2021, the PBoC lowered the upper limit ratio for cross-border financing from 1.25 to 1.0 to encourage outward investments, and before that, on December 11, 2020, it lowered the macro-prudential adjustment parameter for financial institutions from 1.25 to 1.0.

And in response to the sharp appreciation of the RMB at the start of the year, PBoC officials emphasize that the central bank will continue to step in, as needed, to prevent “disorderly fluctuations” in the currency market.

 

 

 

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