China's January foreign reserves fall below $3 trillion

China's foreign exchange reserves unexpectedly fell below the closely watched $3 trillion level in January for the first time in nearly six years, though tighter regulatory controls appeared to making some progress in slowing capital outflows.

China has taken a raft of steps in recent months to make it harder to move money out of the country and to reassert a grip on its faltering currency, even as US President Donald Trump steps up accusations that Beijing is keeping the yuan too cheap. 

Reserves fell $12.3 billion in January to $2.998 trillion, more than the $10.5 billion that economists polled by Reuters had expected.

While the $3 trillion mark is not seen as a firm "line in the sand" for Beijing, concerns are swirling over the speed at which the country is depleting its ammunition, sowing doubts over how much longer authorities can afford to defend both the currency and its reserves.

Some analysts fear a heavy and sustained drain on reserves could prompt Beijing to devalue the yuan as it did in 2015, which could throw global financial markets into turmoil and stoke political tensions with the new US administration.

While Beijing quickly downplayed the fall below the $3 trillion level, the breach could bolster China's argument that it not deliberately devaluing its currency, ahead of the US Treasury's semi-annual report in April on currency manipulators.

To be sure, the January decline was much smaller than the $41 billion reported in December, and was the smallest in seven months, indicating China's renewed crackdown on outflows appears to be working, at least for now.

Economists expect more forceful tightening of regulatory controls after the latest slide, though China's financial system is notoriously porous, with speculators quickly able to find new channels to get funds out of the country.

"With FX reserves below $3 trillion, we can expect capital controls as well as tightening yuan liquidity to continue, as the authorities try to avoid a further drawdown," said Chester Liaw, an economist at Forecast Pte Ltd in Singapore, referring the central bank's surprise hike in short-term interest rates on Friday.

While the world's second-largest economy still has the largest stash of forex reserves by far, it has burned through over half a trillion dollars since August 2015, when it stunned global investors by devaluing the yuan.

The yuan fell 6.6 per cent against a surging dollar in 2016, its biggest annual drop since 1994.

The crackdown is threatening to squeeze legitimate business outflows from China as well, with some European companies reporting recently that dividend payments have been put on hold.

Could have been worse?

The drop in January's reserves could have been worse if not for a sudden reversal in the surging US dollar in January, some analysts said. The softer dollar boosted the value of non-dollar currencies that Beijing holds.

"Based on our calculation, the FX valuation effect alone would lead to a sizeable increase of reserves by $28 billion," economists at Citi said in a note.

Despite tighter capital curbs, Citi estimated net capital outflows intensified to nearly $71 billion in January from $51 billion in December. Adding to the pressure, many Chinese may have traded yuan for dollars to travel overseas during the long Lunar New Year holidays.

The yuan has gained nearly 1 percent against the dollar so far this year.

But currency strategists polled by Reuters expect it will resume its descent soon, falling to near-decade lows, especially if the US continues to raise interest rates, which would trigger fresh capital outflows from emerging economies such as China and test its enhanced capital controls.

The drop in reserves in January was mainly due to interventions by the central bank as it sold foreign exchange and bought yuan, China's foreign exchange regulator, the State Administration of Foreign Exchange (SAFE), said in a statement.

But SAFE said that changes in China's reserves are normal and the market should not pay too much attention to the $3 trillion level.

How low can they go?

While estimates vary widely, some analysts believe China needs to retain a minimum of $2.6 trillion to $2.8 trillion under the International Monetary Fund's (IMF's) adequacy measures, and note that fears of a devaluation would likely spark more intense capital flight.

"The fact that China holds less than $3 trillion in reserves right now means that China has to rethink its intervention strategy," said Zhou Hao, a senior emerging markets economist at Commerzbank in Singapore.

It does not make much sense to keep sharply draining reserves if market expectations of further yuan weakness are unlikely to change, he added.

Source :Times Of Oman