Chinese foreign exchange reserves shrink
China’s gargantuan stash of foreign exchange reserves has got a little bit smaller, shrinking in the final quarter of 2011 for the first time in more than a decade.
China’s reserves fell by $20.5bn as its trade surplus decreased and capital flowed out of the country, much like other emerging markets.
It was the first drop since the Asian financial crisis in 1998, but Beijing still controls almost $3.2tn in official currency reserves – an unprecedented amount for any country and nearly triple Japan’s reserves, the world’s second biggest.
Analysts said the fall was likely to be temporary and China’s reserves would resume rising this year, but that the unmistakable trend was for a slower accumulation, largely because of the country’s narrowing trade surplus.
“That is definitely a good thing, because it means policy is going to be less hijacked by the inflows,” Tao Wang, an economist with UBS, said.
Over the past five years, Beijing pulled in an average of $160bn in fresh reserves per quarter. Although other countries have looked enviously at these riches, they have in fact caused a growing headache for China.
The most obvious problem, albeit a welcome one, has been the question of how to invest the money. Beijing has tried to diversify into everything from oil and gold to stakes in listed companies in Europe and property in Manhattan.
Yet it has ultimately had little choice but to recycle the vast bulk of its reserves into US government bonds, the only asset market big enough and liquid enough to accommodate so much cash. Chinese premier Wen Jiabao has spoken repeatedly of his worries about the safety of China’s investments in the US, but Beijing has carried on buying US Treasuries even as Washington’s debt levels have soared.
A more serious problem for China has been the need to cancel out the domestic inflationary effect of the reserve accumulation. The root cause of the growth in currency reserves has been Beijing’s policy of keeping the renminbi in a managed float against the dollar. The semi-pegged currency obliges the Chinese central bank to buy most of the foreign exchange coming into the country, injecting fresh renminbi into the financial system in return.
To prevent that newly created money from pushing prices higher, the People’s Bank of China must constantly engage in what are known as “sterilisation operations”. It issues bills to banks or forces them to set aside a portion of their deposits as required reserves to mop up the excess liquidity.
In an indication of how burdensome this sterilisation had become, China set banks’ reserve requirements at a record high of 21.5 per cent for much of last year. But the drop in foreign exchange reserves has helped clear the way for Beijing to ease those reserve requirements and, in so doing, release cash into the economy to help stimulate slowing growth.
The central bank has already cut required reserves once, at the end of November, and analysts expect a series of further reductions in the coming months.
But Lu Ting, an economist with Bank of America Merrill Lynch, also cautioned that the decline in China’s foreign exchange holdings was exaggerated by a series of more technical factors.
The valuation effect of a weaker euro, a policy that encourages commercial banks to keep foreign currency in their own hands and the process of settling more trade in renminbi all probably combined to weigh on reserves, he said.
“There is no need for panic about the Chinese economy and financial system,” he said. “It’s unlikely for China to face the risk of a currency crisis or a balance-of-payment crisis.”
China’s reserves fell by $20.5bn as its trade surplus decreased and capital flowed out of the country, much like other emerging markets.
It was the first drop since the Asian financial crisis in 1998, but Beijing still controls almost $3.2tn in official currency reserves – an unprecedented amount for any country and nearly triple Japan’s reserves, the world’s second biggest.
Analysts said the fall was likely to be temporary and China’s reserves would resume rising this year, but that the unmistakable trend was for a slower accumulation, largely because of the country’s narrowing trade surplus.
“That is definitely a good thing, because it means policy is going to be less hijacked by the inflows,” Tao Wang, an economist with UBS, said.
Over the past five years, Beijing pulled in an average of $160bn in fresh reserves per quarter. Although other countries have looked enviously at these riches, they have in fact caused a growing headache for China.
The most obvious problem, albeit a welcome one, has been the question of how to invest the money. Beijing has tried to diversify into everything from oil and gold to stakes in listed companies in Europe and property in Manhattan.
Yet it has ultimately had little choice but to recycle the vast bulk of its reserves into US government bonds, the only asset market big enough and liquid enough to accommodate so much cash. Chinese premier Wen Jiabao has spoken repeatedly of his worries about the safety of China’s investments in the US, but Beijing has carried on buying US Treasuries even as Washington’s debt levels have soared.
A more serious problem for China has been the need to cancel out the domestic inflationary effect of the reserve accumulation. The root cause of the growth in currency reserves has been Beijing’s policy of keeping the renminbi in a managed float against the dollar. The semi-pegged currency obliges the Chinese central bank to buy most of the foreign exchange coming into the country, injecting fresh renminbi into the financial system in return.
To prevent that newly created money from pushing prices higher, the People’s Bank of China must constantly engage in what are known as “sterilisation operations”. It issues bills to banks or forces them to set aside a portion of their deposits as required reserves to mop up the excess liquidity.
In an indication of how burdensome this sterilisation had become, China set banks’ reserve requirements at a record high of 21.5 per cent for much of last year. But the drop in foreign exchange reserves has helped clear the way for Beijing to ease those reserve requirements and, in so doing, release cash into the economy to help stimulate slowing growth.
The central bank has already cut required reserves once, at the end of November, and analysts expect a series of further reductions in the coming months.
But Lu Ting, an economist with Bank of America Merrill Lynch, also cautioned that the decline in China’s foreign exchange holdings was exaggerated by a series of more technical factors.
The valuation effect of a weaker euro, a policy that encourages commercial banks to keep foreign currency in their own hands and the process of settling more trade in renminbi all probably combined to weigh on reserves, he said.
“There is no need for panic about the Chinese economy and financial system,” he said. “It’s unlikely for China to face the risk of a currency crisis or a balance-of-payment crisis.”
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