Five questions on China’s forex reserves

CHINA’S cash stockpile fell last month to just below $3 trillion, its lowest level since 2008 and a trillion dollars down from its record high seen in mid-2014.

The figure is still more than double second-placed Japan’s $1.2 trillion. However, it’s shrinking, setting off alarm bells around global markets.

So, what is the big deal? Here are five questions and answers.

What are China’s forex reserves?

The total amount of cash, bonds, and financial assets in a foreign currency held by China’s central bank, the People’s Bank of China. While it does not disclose exactly which currencies it holds in what proportions, economists believe roughly two-thirds is in US dollars, particularly US Treasury bonds.

Why does it matter?

China’s mountain of foreign exchange was growing rapidly as it ran an enormous trade surplus with the rest of the world and many viewed it as a symbol of its national power.

With so much of the holdings in US Treasury bonds, US politicians worried Beijing could use them as leverage. These fears, however, have not yet materialised.

Why has it shrunk?

The dollar has rallied since Donald Trump’s November US election win as investors bet he will push on with his promises of big spending and tax cuts that will ramp up inflation and force the Federal Reserve to lift interest rates – attracting investors to the US for better returns.

This has weakened China’s holdings in other currencies, creating a large paper loss.

However, slowing economic growth has spurred capital flight, with citizens, investors, and businesses moving large sums of money offshore – causing the yuan currency to weaken further and it is now near eight-year lows.

To stem outflows and stabilise the yuan, the central bank has been using its war chest to buy up the currency: its foreign exchange reserves slipped $12.3 billion to $2.998 trillion in January alone, People’s Bank of China data showed.

Is this a problem?

Observers have seen the $3 trillion threshold as psychologically important, and some expect that capital flight will increase now.

But Beijing is working hard to curb outflows through regulations, and it recently rolled out rules on buying foreign currency and making it tougher for firms to make overseas acquisitions.

“Policymakers may eventually have to resort to more forceful steps such as formally re-imposing restrictions on outflows,” said Louis Kuijs of Oxford Economics.

Any risks from Trump?

Yes. If the tycoon follows through on his protectionist rhetoric and meets promises to stimulate the US economy, the greenback would likely rise further. That in turn would attract more capital flows from China and put further downward pressure on the yuan.

Keeping the unit stable could get very expensive for Beijing. But the alternative – letting the yuan depreciate sharply – could roil markets and fuel instability.

“The PBoC is caught between the devil and the deep blue sea, facing a choice of either continued slow erosion of [forex] reserves, or further currency adjustment that could be destabilising for China and may also cause turmoil in Asian currency markets,” said Rajiv Biswas of IHS Global Insight.