Chinese foreign exchange reserves data was released today – Reserves stood at $1.95 trillion at the end of March 2009, just under $8 billion more than at the end of 2008 – a much slower pace of growth than in 2007 or 2008.
Bloomberg notes “The currency reserves plunged by $32.6 billion in January, the biggest monthly decline since Bloomberg started compiling data in 1996. The holdings shrank by $1.4 billon in February and expanded $41.7 billion in March.”
To a large extent this slow growth was not a surprise. The $30bn nominal drop in fx reserves was leaked to the press a few weeks ago – and as usual, the leak was pretty accurate. Furthermore, it fairly consistent with other indicators that Chinese macro conditions were under severe stress at the beginning of the year.
Adjusting for valuation – changes in the value of non U.S. assets -would suggest that the net increase of reserves in q1 might be slightly higher – perhaps $35bn, assuming just under 70% USD, 25% Euro and the rest in JPY and GBP. If so this pace of accumulation would still be the slowest since mid 2004, when Chinese reserve growth was starting to pick up. Moreover, the reserve growth is much less than the accumulated trade surpluses from January to March and FDI which reach an estimated $80 billion. The sharp decline in imports led to record trade surpluses from November -January, boosting the current account. Although the trade surplus has been much smaller in February and March, about $5bn and about $18bn respectively, it is still quite large. Similarly, although the pace of growth of FDI has slowed, so far it has been around $5bn a month (a number I used as an estimate for March – data will be released later this week. Economists usually fixate on the difference between the reserve accumulation and the sum of the trade surplus and FDI, as well as interest payments with any difference – ‘unexplained flows’ thought to be hot money capital inflows. Given that the the reserve accumulation is now less than the reserve growth, hot money outflows now seem to be the order of the day. even using conservative estimates for interest income, $50bn is a plausible estimate for hot money outflows in Q1.
There are a few other explanations for lower reserve growth though
– The PBoC is receiving lower payments on its existing stock of US assets as yields have fallen. However, despite the lower payments, the PBoC should still be receiving significant enough payments.
– Losses on the equity portfolio. Estimates based on research done by Brad Setser suggest that SAFE, who manages china’s fx reserves went heavily into equities just before they took their slide into bear market territory. The U.S. survey data suggests that Chinese holdings of U.S. equities increased by almost $90bn from June 2007 to June 2008. Any returns on the existing portfolio of equities would have been quite minimal. and given that only a very small share, if any of the QDII funds were bound for the U.S. the central bank likely accounts for this discrepancy. However, it is thought that SAFE does not mark to market , which would rule out investment losses as a source of the dip.
Either way it seems clear that there have been several months in which China experienced capital outflows. In fact depending assumptions of the currency composition and return on China’s investments, China may have experienced outflows from October 2008-March 2009, which would match with the near stall in the Chinese economy in this period.
However the pace of capital outflows seems to have slowed in February and March coming more into balance perhaps as the economic news flow out of China started pointing to a nascent stabilization. The outflows at the end of Q4 and in Q1 may reflect the outflows from Chinese investors, mostly corporations that rmb appreciation was unlikely and more significantly that depreciation was now a possibility. With the Chinese government pump-priming and credit extension well on course, those outflows may have waned. Yet, in the absense of external demand, return of assets may take some time given the removal of the appreciation expectations that ruled in early 2008 contributing to record reserve growth which peaked in Q2 2008. Given the expectation that China has returned to a defacto peg, capital inflows may be wary to make curency bets. Although China may continue to experience inflows if the its economic outlook seems to outpace global challengers, it may be unlikely to allow appreciation. A couple of questions still remain
– What happened to all $ assets that the banks had to hold as part of the reserve requirement hikes
– And who holds all the increase in China’s (visible) holdings of US assets. China has been shifting around within its US assets for some time and in recent months has been adding to its short-term claims on the U.S. ramping up holdings of t-bills and the like . Brad Setser has argued that this may though be the result of a shift from US money market funds to shorter-term claims. At least through January, Chinese investors were increasingly buying such short-term claims. February data, out later this week will provide some clues. the pace of US asset accumulation by China seems unsustainable especially given the slower pace of reserve growth.
Writing about the leaked estimate of fx reserves in January, Michael Pettis noted that increasingly it may be non-government investors (or at least not the central bank and CIC) that account for the management of China’s foreign assets
“Chinese investors who have taken money out of the country, on the other hand, will now effectively be responsible for recycling the Chinese current account surplus. They might decide to buy US Treasury bonds (and I suspect indirectly and directly many will), but they could also buy gold, Venezuelan bolivares, Moroccan real estate, or in fact anything else they choose, and it is their buying that will determine how the Chinese trade surplus gets allocated among China’s trading partners.”
The slower pace of reserve growth comes at a time when Chinese investors have been making other foreign purchases, including extensive loans by the CDB to resource companies. Not all of these have been finalized yet (and the one to Rio Tinto seems to be on hold given Australian regulatory processes) but they account for several tens of billions of dollars. Other acquisitions could also account for such outflows. However, with the fears of a devaluation of the RMB at the turn of the year and currently no expectations of any appreciation, hot money seems to have left China, seeking returns elsewhere. With respect to commodities many actors (government, SOEs, quasi public etc) all seem to be more interested in commodities, particularly when the commodities were at their weakest. China seems to be snapping up both actually commodities to restock and extend its reserves as well as stakes in foreign resource companies. Overtime this may be a clear path.
China still though does have limited options for managing its reserves (for more see the RGE Global outlook materializing for advisory level clients in upcoming weeks) especially since stopping the purchases of U.S. assets might mean accepting the loss on a stock of other assets. However, it does seem likely that the U.S. may not be able to count on China for purchases of U.S. assets as much as in the past even as the U.S. faces record financing needs.
Finally – its worth noting that the sluggish growth in Chinese reserves is consistent with global reserve accumulation… or rather disaccumulation trends. Global reserve growth stock peaked in about q3 2008, according to IMF data. Since then the only major reserve accumulators were Taiwan and a couple of
oil exporters. Taiwan, like China, experienced record trade surpluses as import contraction outpaced that of exports. Oil exporters are now spending their reserves. Saudi Arabia’s non-reserve foreign assets and assets the central bank manages on behalf of the pension funds fell about $23 billion from November 2008-February 2009 as oil output and revenue shrank and more funds were deposited in domestic banks. Given the fall in revenue to about 1/3 of the average in 2008 given the production cuts and price fall, SAMA is likely now selling some of its assets to meet domestic spending needs. Other countries were spending their reserves, though the pace of such outflows has slowed in Q1. but the trend of heavy reserve accumulation by emerging economies seems to be on hold. It may like a range of other dynamics, be much more subdued in absence of leverage.