Fall in China’s forex reserves will not lead to tighter liquidity

Worries over falling forex reserves and tightening liquidity in China are overblown and there are misconceptions over these drawdowns, says an investment bank and a top credit ratings agency.

Official data released earlier this month showed China’s foreign-exchange reserve fell by US$93.9 billion in August, its biggest monthly drop ever. Fitch calculates that US$100 billion of the forex drop during the first half can be attributed to the 4.3% trade-weighted appreciation of the US dollar.

Wang Tao, chief China economist with European lender UBS, said worries over China’s internal liquidity conditions are a bit exaggerated.

“Although FX reserves rose rapidly between 2002 to 2011, China’s base money growth actually did not expand as fast. This is because even though its balance sheet expanded, the PBOC used multiple tools to sterilize the inflows, including issuing central bank bills and raising reserve requirements to ‘freeze’ much of the liquidity,” Wang said in the report released Tuesday.

Fitch Ratings said Tuesday that shrinking global forex reserves “does not directly risk a ‘quantitative tightening’ effect on developed markets.”

Liquidity should remain little changed, even as central banks in emerging market such as China and Saudi Arabia pare back their forex holdings, Fitch said.

“When central banks other than the Fed sell the dollars they have obtained from selling US Treasuries, those dollars remain circulating within the financial system - and could even end up reinvested in US Treasuries,” Fitch said.