Even though China’s trade surpluses continue at record and near record levels (imports are falling faster than exports), China’s foreign exchange reserves are not even close to keeping pace.
Readers may recall that a massive amount of money flowed into China, a good bit of it disguised (FDI was one of the suspect categories) because RMB appreciation looked to be a one-way trade. Given China’s currency controls, there were limited options for playing that point of view from overseas, hence the funds influx.
But now that China has quietly gone back to a hard peg to the dollar, the dreams of a quick profit have been dashed, and the hot money is making an exit. Per Brad Setser (part of a longer and useful post, hat tip reader Michael). The reserve requirement mention comes about because the PBoC requires banks to hold some of their reserves in dollars, which means that the true FX reserves are greater than the official reserves:
There is only one way to square a record trade surplus with the sharp fall in reserve growth:
Hot money is now flowing out of China. Here is one way of thinking of it:
The trade surplus should have produced a $115 billion increase in China’s foreign assets. FDI inflows and interest income should combine to produce another $30-40 billion. The fall in the reserve requirement should have added another $50-55 billion (if not more) to China’s reserves. Sum it up and China’s reserves would have increased by about $200 billion in the absence of hot money flows. Instead they went up by about $50 billion. That implies that money is now flowing out of China as fast as it flowed in during the first part of 2008.
And in December, the outflows were absolutely bruta….$70 billion plus in monthly hot only outflows … That’s huge. Annualized, it is well in excess of 10% of China’s GDP. Probably above 15% …
No wonder the PBoC is worried about unusual swings in capital flows.
China can absorb such a swing in capital flows better than most….
In one sense this is good – it makes it harder for China to engineer a controlled depreciation against the dollar. And that may mute internal calls for China to prop up its exports with a depreciation. China presumably doesn’t want to create perception that the renminbi is a one way bet down after it was long considered a one-way bet up….
Over time, if hot money outflows subside, China’s reserve growth should converge to its current account surplus (plus net FDI inflows). That implies ongoing Treasury purchases – though not at the current pace – barring a shift back into “risk” assets. And if hot money outflows continue, watch for Hong Kong and Taiwan to buy more Treasuries. The money flowing out of China doesn’t just disappear … it has to go somewhere.