China economy

‘It’s a kind of vicious cycle’: China’s foreign reserves fall by record US$108b in December

PUBLISHED : Thursday, 07 January, 2016, 5:34pm
UPDATED : Friday, 05 February, 2016, 12:50pm

China’s foreign exchange reserves fell more than US$100 billion in December as the central bank struggled to fight massive capital outflows and fend off attacks on the yuan.

Markets were taken by surprise as data released by the People’s Bank of China on Thursday revealed the reserves had fallen a record US$107.9 billion – the first time a monthly fall has surpassed the US$100 billion mark and the tenth monthly fall of 2015.

The new data meant that for 2015 as a whole there had been a fall of US$512.7 billion to US$3.33 trillion – lower than the US$3.4 trillion expected by economists and down from US$3.84 trillion at the end of 2014.

The meltdown of China’s foreign exchange reserves picked up in August after the PBOC ended a soft peg to the US dollar and targeted a basket of currencies on August 11. The move resulted in sharp depreciation of the yuan against the greenback and triggered frequent intervention by the central bank to defend the yuan. August’s fall of US$93.9 billion was second only to the drop in December.

“It is a kind of vicious cycle – the weaker the yuan, the more capital flight,” said Shen Jianguang, chief economist with Mizuho Securities Asia in Hong Kong. “The big fall in December foreign exchange reserves is another blow to market confidence in the yuan.”

He said the PBOC was sending unclear messages to the market, causing additional confusion and uncertainty among investors.

“On one hand, the government is saying that there is no fundamental basis for yuan depreciation, but on the other hand, the yuan is weakening day by day – it will hurt the government’s credibility”.

Liu Dongliang, an economist with China Merchants Bank, said the steep fall in December might explain why the central bank suspended cross-border currency business for some foreign banks.

The larger-than-expected drop in foreign exchange reserves may strengthen bets on a weaker yuan and fuel speculation that the central bank will find it more difficult to intervene in the exchange rate, he said.

The central bank set the official midpoint rate on the yuan at 6.5646 per dollar on Thursday, the lowest since March 2011, while the offshore yuan traded at an intraday low of 6.7511, the lowest since October 2010.

Economists are even discussing whether the rate might weaken to 7.0 level within the year.

“The fact that the market cares so much about changes in the foreign exchange reserves implies we still rely on reserves to defend the exchange rate and are concerned about whether our ammunition is enough or not, “ said Lu Zhengwei, chief economist at Industrial Bank. “But the foreign exchange reserves can only decide how long we can [fend off] depreciation expectations. The best way is to speed up market-oriented exchange rate reform, but not try our luck for an easing in [downward] pressure in future.”