Trade deficit and yuan plunge hit forex reserves

CHINA'S soaring trade deficit and central bank intervention in the country's swap markets has significantly depleted foreign exchange reserves.

Reserves have fallen by US$520 million since the end of last year, to stand at $18.8 billion at the end of June, the official China Daily reported yesterday.

The reserves slide follows a 10.5 per cent drop last year and economists have warned that if the trend continues China's foreign currency holdings could fall to dangerously low levels within the next few years.

The mainland's foreign debt stood at $69.3 billion at the end of last year, and while the debt service ratio is still within internationally accepted limits, economists said it was edging towards to the danger zone.

''The current level of reserves is acceptable but if the trade deficit continues to grow at the rate it has been then there will definitely be problems in two or three years,'' a Western financial analyst in Beijing said yesterday.

A Bank of China official said privately that the continuing fall-off in reserves was a cause for concern in senior government circles.


''There is a determination now to really boost exports so that all debt repayments can be met,'' he said. ''China does not want to go the same way as Latin America.'' But despite intense efforts by the Government to rein in the deficit, there is little evidence so far to suggest they have been successful.

Imports rose by a staggering 39.6 per cent in July, compared with the same period last year, to reach $8.77 billion, producing a monthly deficit of $1.14 billion.

And the head of China's state-run oil corporation Wang Tao conceded earlier in the week that the mainland would eventually become a net importer of oil, thereby effectively eliminating a major source of foreign exchange.

Oil imports are expected to increase by 2.7 million tonnes this year to 15 million tonnes, while exports are expected to fall 1.7 million tonnes to 19 million tonnes by the end of the year.


While much of the fall in foreign exchange reserves can be attributed to the worsening trade deficit, another significant cause of the depletion is believed to be the People's Bank of China's massive intervention in the currency swap markets earlier thisyear.

The central bank is reported to have dumped hundreds of millions of dollars on the main swap markets in an attempt to halt the rapid depreciation of the yuan which followed the lifting of price ceilings on the markets on June 1.


Although the swap market has now stabilised, given the volatility of both the domestic and international currency markets over the past year, there is still a fear that the bank might be forced to intervene again later in the year, further depleting reserves.

The central bank, criticised in a new World Bank report for failing to properly regulate the financial sector, has vowed to focus in the latter half of the year on ensuring that funds be directed towards key state projects and agriculture rather than speculative projects which have led to the overheating of the economy.

Analysts warned, however, that it would take a major effort of political will to ensure the bank carried out its objectives effectively.