China's funds for foreign exchange drop unexpectedly

China's funds outstanding for foreign exchange fell unexpectedly in August, underscoring short-term pressure of capital outflow, according to data released Monday by the People's Bank of China (PBOC).
Considered part of China's broad money supply, funds for foreign exchange stood at 29.5 trillion yuan (4.79 trillion U.S. dollars) by the end of August, down 31.2 billion yuan from a month ago, the PBOC data showed.
The decline in August reversed a growth in funds for foreign exchange seen in July, according to the PBOC, China's central bank.
The decline surprised many analysts, as China's trade surplus in August jumped 77.8 percent year on year to an all-time high of 49.8 billion U.S. dollars, according data released by the General Administration of Customs last week.
"The decline of funds for foreign exchange in August is beyond our expectation," said Zhong Zhengsheng, a macroeconomic analyst with Guosen Securities. "On one hand, the trade surplus in August reached new high; on the other hand, the yuan has kept appreciating in the month."
A warming domestic equity market ahead of the linking of Shanghai and Hong Kong stock exchanges also made the decline a little bit hard to understand.
The benchmark Shanghai Composite Index gained 1.5 percent in August as overseas investors were eager to build up their stock positions in China's A-share market to profit from the Shanghai and Hong Kong arrangement.
If the inflow of foreign capital continues, as suggested by the trade data, Zhong said, the only way to explain the drop was that Chinese individuals are more willing to hold foreign exchange.
The pessimistic outlook on China's economy may lead to worries that the yuan will depreciate, Zhong said.
Lian Ping, chief economist at the Bank of Communications, said the widening trade surplus and warming stock market failed to offset bad news of across-the-board weakness of economic indicators in August.
"Worries about China's economy had worsened. The property market was slowing down, the foreign direct investment was heading for a decline while the U.S. dollar was on the rise," Lian said. "All those factors made Chinese companies and individuals more reluctant to sell foreign exchange assets.
Lian estimated that it was unlikely China would register rapid growth in funds for foreign exchange in the coming months.
As China accelerates its outbound direct investment (ODI), capital outflow led to the shrinking funds for foreign exchange.
China's ODI in non-financial sectors soared 84.9 percent from the previous year to 9.21 billion U.S. dollars in July, compared with a year-on-year decline of 5 percent in the January-June period.
Chinese investors made 52.6 billion U.S. dollars in ODI for the first seven months of 2014, following a record high of 108 billion U.S. dollars seen last year.
Chinese banks saw greater volatility in funds outstanding for foreign exchange since the beginning of this year.
New funds for foreign exchange rose to 437 billion yuan in January, the highest level since October last year. The number kept falling month by month in the first half of this year, with a fall in total funds outstanding in June.
The drop triggered discussion as to whether the central bank should lower the reserve requirement ratio (RRR) to allow more liquidity into the market.
Zhong said it was hard for the PBOC to move that quickly just based on the fluctuation within a single month.
"Only when the outflow of funds for foreign exchange continues and with a deficit of the money base will the PBOC resort to a full scale RRR cut," Zhong added.