China Foreign-Exchange Reserves Drop First Time Since 1998

China’s foreign-exchange reserves dropped for the first time in more than a decade as foreign investment moderated, the trade surplus narrowed and Europe’s crisis spurred investors to sell emerging-market assets.

The holdings, the world’s biggest, fell to $3.18 trillion on Dec. 31 from $3.2 trillion Sept. 30, People’s Bank of China data released in Beijing showed today. The quarterly drop was the first since the midst of the Asian financial crisis in the second quarter of 1998, according to data compiled by Bloomberg.

The decline underscores forecasts for the central bank to ease monetary policy, and may bolster China’s resistance to appreciation in its currency. PBOC Governor Zhou Xiaochuan said in remarks published this month that a global downturn may lead to “large” capital withdrawals this year, highlighting a shift in risk from the influx of speculative funds that China had opposed during the 2009-2010 world economic rebound.

“It indicates an absence of flow pressure for the yuan to appreciate, which may lead the central bank to slow the pace of appreciation,” said Tim Condon, chief Asia economist at ING Financial Markets in Singapore. “This will also reduce the need to absorb hot money inflows, allowing the central bank to cut banks’ required reserve ratio.”

Monetary Steps

Condon, who previously worked at the World Bank, said the PBOC may lower the ratio of assets banks must hold in reserve by 2 percentage points in 2012. The bank cut the ratio for the first time since 2008 last month.

China’s foreign-exchange holdings reached a record $3.27 trillion in October and then fell in the following two months, the central bank data showed, indicating a decrease of $92.6 billion in November and December.

Much of the decline may be due to a lower value of the reserves held in currencies other than the U.S. dollar, said Cui Li, a Hong Kong-based economist at Royal Bank of Scotland Plc who previously worked at the International Monetary Fund.

While China doesn’t provide details on the distribution of its holdings, the country bought euros in 2011, with policy makers flagging support for efforts to aid Europe’s battle to resolve the sovereign-debt crisis. The euro fell 3.2 percent against the dollar in the last quarter of 2011.

Debt Repayments

Corporate repayments of dollar debt also contributed, according to Guan Tao, director of the international payments department at the State Administration of Foreign Exchange, Market News International reported today.

The decrease in reserves may also open the door to a widening of the yuan’s trading band, said Dariusz Kowalczyk, a senior economist at Credit Agricole CIB in Hong Kong. The currency is allowed to trade 0.5 percent above or below a daily reference rate for the dollar set by the central bank. Zhou has signaled he’ll be more prepared for greater fluctuation once there’s reduced risk of one-way bets on the currency.

China’s yuan rose 0.2 percent, to 6.3066 at the 4:30 p.m. close in Shanghai, its first advance in daily trading this year. The Shanghai Composite Index retreated 1.3 percent.

The drop in holdings was the first since the throes of the Asian financial crisis in 1998, when nations from South Korea to Thailand saw reserves depleted as investors fled the region. East Asian nations later rebuilt their holdings and restructured their financial systems, helping the region lead the global economic rebound in the past three years.

Stock Slump

Countries including South Korea, Indonesia and India used some of their reserves to support their currencies in September 2011, when European debt woes deteriorated as Greece teetered toward a potential disorderly default. The MSCI Asia Pacific Index of stocks dropped 16 percent in the second half of last year, when the Shanghai Composite Index slid 20 percent.

HSBC Holdings Plc is selling its retail bank in Thailand, a market it entered more than a century ago, as the European bank sheds assets to boost its capital base at a time when Europe’ debt crisis saps profits and regulators increase capital requirements.

For China, the Europe-led damage to the global recovery has hit the nation’s exports, which rose the least in two years in December, adjusted for holiday-period distortions. For 2011, the trade surplus narrowed 14.5 percent to $155 billion, the third straight annual decline since a record $298 billion in 2008.

Capital Outflow

At the same time, capital outflow likely did contribute to a slide in China’s reserves late last year, analysts said. An estimated $34 billion may have moved out in the third quarter, driven by a mix of escalating concern over a hard landing for China’s economy, the worsening euro area crisis and speculation that the yuan may fall against the dollar, Lu Ting, an economist at Bank of America Corp. in Hong Kong, said in a Jan. 5 report.

Lu said today that speculation of about $100 billion in hot money flowing out in the fourth quarter was probably overestimated.

China should use more of its reserves to make direct investments overseas, Zheng Xinli, vice president of the state-backed China Center for International Economic Exchanges, said at a forum in Beijing this week.

The nation needs about $1 trillion of its holdings for international payments purposes and should use the remainder to buy assets such as exploration rights for energy and resources, he said. China should also set up processing-trade zones overseas which could spur exports of parts and raw materials, he said.