China Reserves Slide Seen Easing, Yet Dam-Bust Still a Riskby
Weaker U.S. dollar has relieved pressure on the yuan
Test will come if Fed tightening expectations return
China is set to report a further easing in pressure on its foreign-exchange reserves in March, a shift that’s been helped by a hearty dose of good luck in the form of a weaker greenback.
While authorities have stemmed a record tide of departing money with stricter currency rules and repeated statements they don’t want a big devaluation in the yuan, there’s little sign yet that the appetite among Chinese investors to diversify abroad has been sated. And the central bank’s embrace of liquidity injections may result in an increase in pressure for funds to leave the country.
China has been one of the emerging-market beneficiaries of the U.S. Federal Reserve’s dialed-back outlook for interest-rate increases, underscored by Chair Janet Yellen’s remarks last week. After an estimated $1 trillion in funds left China in 2015, recent months have shown diminishing pressures. Data Thursday are forecast to show China’s reserves dropped in March by the least since October, when they last gained.
Chinese stocks rallied in March, and the yuan appreciated against the dollar, in a far cry from the turmoil seen in January. Signs of economic stabilization at home, including a rebound in the outlook for the struggling manufacturing sector, have also helped to turn sentiment. But the sands may shift anew.
"Don’t treat this relative calm as a permanent feature," said Shang-Jin Wei, chief economist at the Asian Development Bank. "In a few months, U.S. fundamentals could change."
There are other risks too: another stock-market rout or real-estate slump could spur pressure to take money out of China, and weakening exports or higher import prices would dent the current account surplus -- a key defense against capital outflows.
Since January, the People’s Bank of China has moved against speculators betting against the yuan and made it harder for its people to get money out of the country. It has also run down its reserves to help support the yuan. The March forecast for a level of about $3.192 trillion represents a drop of about 20 percent from the peak.
"China’s official FX reserves remain huge and can easily afford such a run-off for a while," said Warren Coats, a former economist at the International Monetary Fund who advises central banks around the world. "That is largely a good thing as China currently has reduced options for domestic investment as unproductive, mis-investments work themselves off."
Since the end of February, outflows have become "clearly muted," according to economists at Societe Generale SA. The bank expects that reserves increased in March, likely reaching $3.25 trillion.
One positive for China is that it’s closer now to working off a load of foreign-currency borrowing taken on to place bets on yuan appreciation, back before Chinese leaders unexpectedly devalued it in August. Those bets contributed to a rapid buildup in U.S. dollar debt over several years to 6 percent of gross domestic product, according to research by Citigroup Inc.
"We may not be too many hundreds of billions of dollars -- and not too many months or quarters -- away from being able to stop worrying about the very close connection between China’s capital account and U.S. monetary policy," Citigroup Inc. head of emerging-market economics David Lubin wrote in a recent note. Yet for now, "when expectations of U.S. monetary tightening gather pace, that will accelerate capital outflows from China."
Another worry on the immediate horizon is a run-up in domestic liquidity relative to the level of reserves. The ratio of the M2 gauge of money supply to the currency holdings is now the highest in more than a decade.
If Chinese residents face stepped-up incentives to move more of their $21.4 trillion worth of local yuan deposits out, that would rapidly escalate the challenges for policy makers.
"Households hold the key," said Rob Subbaraman, Nomura Holdings Inc.’s chief economist for Asia ex-Japan. To restore confidence, China will need to push through painful structural reforms to cut back debt and overcapacity, he said.
It remains to be seen whether March was the calm in the storm, or a return to fair weather for China’s capital flows.
"With the measures to clamp down on outflows and the temporary stabilization of the exchange rate, you could see a more modest decline" or even some gain in reserves, said Stephen Jen, co-founder of SLJ Macro Partners LLP in London. Even so, "the story is not over" for the diversification abroad of Chinese savings, which will put pressure on reserves and the yuan, he said.