Concerns about China’s economy making a hard landing, fears of an exchange rate collapsing because of capital flight, and in its wake worries that currency reserves would be sold off – these were the ingredients that before year-end 2017 influenced the one or other outlook on China. Fortunately, we have always opted to be slightly more cautious and considered in particular the trend for currency reserves with less of a furrowed brow. The combination of economic stabilization, the globally weak USD, controls on capital flows, and other threatening gestures made by Chinese officials in the direction of the financial markets have not only brought the reduction in currency reserves to a halt, but have since even sparked a convincing reversal of the trend.
Following its all-time high in July 2014 (of just short of USD 4,000 billion), China’s currency reserves had plummeted by almost USD 1,000 billion by early 2017. Last January, albeit temporarily, the level actually dropped below the psychological threshold of USD 3,000 billion, triggering heated discussions on for how long China’s reserves would suffice. In this regard, the past year 2017 was decidedly more successful for China’s central bankers. The latest data for December confirm a convincing increase in the reserves of almost USD 130 billion for the last 12 months with the figure now at about USD 3,140 billion. In other words, the reserves have climbed for 11 consecutive months and have regained the level last seen in September 2016.
The global trend for the USD plays a key role in reserves management – a factor that China’s officials cannot simply influence at will (at least not without triggering a global currency war.) As regards 2018, said USD weakness will presumably not ebb completely, but certainly not be as sharp as the momentum seen in 2017. In terms of China’s currency reserves, this means the ‘all clear’ from two sides: Firstly, the reserves are at the moment experiencing a positive valuation effect caused by the exchange rate: Reserves not denominated in USD (in particular in EUR, but also in AUD, GBP, JPY,…) have appreciably gained in value, which would have substantially influenced China’s reserves even without any changes in its intervention policy. Secondly, given the USD trend the need for active market intervention in USD-CNY otherwise used to block off the feared flight of capital (or quite generally to combat any undesired Yuan weakness) has been eliminated. The fact that the USD-CNY rate has clearly dipped from its trend high of just below CNY 7.00 (January 2017) and is now already below CNY 6.50 (January 2018) reflects this change in sentiment. China’s officials have successfully allayed market expectations such that there is now no need to intervene to support the Yuan and thus no reserves need to be “gobbled up”.