China’s dwindling forex reserves raise worries

Investors are wondering how long China’s dwindling forex reserves — down to $3.5tn from a peak of $4tn in June 2014 — can hold out.

Capital is flowing out of China at a record pace and the central bank is drawing down reserves to support the renminbi after its recent dramatic fall.

A lack of clarity over how China calculates its reserves and how much is readily available to deploy at short notice has intensified these concerns.

Amid concerns about slowing growth and rising bad debt in the banking system, investors have viewed China’s massive forex pile — the world’s largest — as the ultimate guarantor of financial stability.

As growth slows and bad debt rises, investors have viewed China’s massive forex pile — the world’s largest — as the ultimate guarantor of financial stability.

The prospect that reserves could be quickly exhausted raises doubts about the government’s ability to ward off crisis. It also limits the central bank’s ability to continue foreign exchange intervention, which may have cost as much as $200bn in August alone.

“The PBoC’s war chest is sizeable, no doubt, but not unlimited,” Wei Yao, China economist at Société Générale, wrote recently. “It is not a good idea to keep at this battle of currency stabilisation for too long. We think that $1tn is the absolute maximum the PBoC can sell.”

The composition of China’s reserves is a state secret and the figures themselves remain mired in confusion. China’s reserves are managed by the traditionally staid State Administration of Foreign Exchange, which typically put its money in US government bonds.

But the low returns that Safe earned on its conservative portfolio led the government to launch a sovereign wealth fund, China Investment Corp, in 2007 to pursue riskier and less liquid investments. In recent years, rivalry between the two encouraged Safe to dabble in other investments such as British office buildings and Italian banks. But while CIC’s investments do not appear in official reserve figures, it is not clear if Safe’s CIC-style forays do.

Another source of mystery is China’s offshore intervention. The PBoC has traditionally confined its currency interventions to the domestic market, but recently it has bought offshore renminbi in an effort to narrow the spread between the onshore and offshore rates. Analysts suspect Safe may count offshore renminbi, known as CNH, as “foreign” reserves — in effect making its reserves look much bigger than they are.