A trillion-dollar question on China’s forex dilemma: just how low should its reserves go?

China’s foreign exchange reserves these days are like a melting iceberg under the sun.

Although the reserves are still the biggest in the world, researchers and investors are wondering: are they enough for China?

On the surface, the answer is obvious, given the US$3.33 trillion it has is enough to cover the country’s imports for over 20 months, well above the usual benchmark of six months. It’s also more than enough to cover all outstanding short-term debts. China’s reserves are almost triple the size of Japan’s total, which is the world’s second-biggest.

But the change is worrying – the monthly fall in December was the first-ever single month fall over US$100 billion for China.

“Whether China’s foreign exchange reserves are sufficient depends on what the People’s Bank of China wants to do,” Zhang Ming, a researcher with the Chinese Academy of Social Sciences, wrote in a note. If the central back dispersed speculation of a weaker yuan, the reserves would be enough, Zhang wrote.

“But if the central bank continues to intervene against the market by selling US dollars and buying yuan in the quest for a stable short-term exchange rate, and the opening up of the capital account is accelerated, China’s reserves may not be enough to deal with yuan depreciation and money outflows,” he wrote.

Broad money supply, M2, was another benchmark for reserves, Zhang wrote. A country with a fixed exchange rate system needed to have reserves equivalent to up to 20 per cent of its M2. In China’s case, that was up to US$4.26 trillion, Zhang wrote.