China: RMB and Dollar Reserve Concerns

Published on December 17, 2020

People’s Bank of China sources note a steady flow of capital into Chinese bonds, stocks and investment projects, and expect those inflows to continue next year as the Federal Reserve, European Central Bank, and other major central banks continue to pump massive liquidity into their financial systems.

China’s central bank, however, is keen to avoid an overvaluation of the Renminbi, and threw a speed bump into the rapidly rising currency as it approached the psychological 6.5000 level against the US Dollar (see SGH 12/10/2020; “China: Sensitivity Around 6.50 RMB”).

*** Those concerns over potentially longer term dollar weakness, and the expansion of the US government debt load, are now spilling over into concerns over the excessive proportion of dollar denominated assets in the country’s FX reserves, which now stand at $3.178 trillion; and from what we understand, the central bank will now seek to more actively increase its holdings of Euro and Yen assets in order to chip away at its ballooning dollar reserves. ***

Tempering RMB Inflows

In order to offset inflows and curb excessive RMB strength next year, the PBoC will look to stimulate capital outflows through the encouragement of overseas direct investments that are “consistent with companies’ core businesses,” and to resume the use of the “countercyclical adjustment factor” in setting the midpoint of the RMB’s daily allowable trading range to signal its preferences.

To reinforce that determination, officials point to actions taken last week intended to reduce domestic companies’ ability to borrow overseas (an effective shorting of foreign currencies), and a decision in October to lower the reserve requirement ratio for financial institutions when conducting certain FX transactions down to zero that was also intended to curb the surging RMB.

But in looking at China’s massive dollar reserves, officials fret that the US debt already stands at a disturbing level and see the incoming Biden administration facing a daunting challenge in reviving the US economy under what they believe to be limited political room for fiscal expansion. They are increasingly concerned with the prospect of more US government bond issuance, and a continued flooding of the markets with dollar liquidity that would erode the attractiveness of the US assets on Beijing’s books.

And, so, an official warns, “the only right way [to manage that risk] is to reduce assets held in US dollars as the yield of US Treasury bonds continues [at these lows]…We will hold more foreign exchange in EUR and JPY to reduce risks and solve the problem of the excessive proportion of US dollars in our reserves.”

Ballooning Reserves

Indeed, in November, China’s FX reserves rose by a whopping $50.508 billion, or 1.6%, from October, from $3.128 trillion to $3.178 trillion. It is the highest level of reserves since August of 2016 and the largest monthly increase since September of 2013. To put that in perspective, China’s FX reserves grew by a total of $70.566 billion through the first eleven months of the year.

The PBoC attributes just over half, or $26.6 billion, of the $50 billion November FX reserve expansion to foreign exchange translation effects, with asset price changes, especially the sharp rise in global equity indices, accounting for another $19.7 billion of that spike.

And while the exact composition of reserves is sensitive, our understanding is that the pace of euro asset expansion continues to lag the expansion in USD assets, albeit just nudging the greenback when combined with the Japanese yen.

In the meantime, the PBoC notes that the RMB central parity rate appreciated by 1,450 “basis points,” or 2.1%, from 6.7232 to 6.5782, against the dollar through November alone, an appreciation rate that was mirrored in both the offshore and onshore markets.  

Having said that, they stress that the central bank refrained again in November from direct intervention, marking 46 consecutive months that the PBoC has not sold USD or RMB in the spot FX markets.



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