Tuesday, June 7, 2016

China Forex Reserves Shrink, Renewing Capital-Flight Concerns

Beijing is trying to diversify more of its reserve assets to lessen its dependence on the dollar. ENLARGE
Beijing is trying to diversify more of its reserve assets to lessen its dependence on the dollar. Photo: Reuters

BEIJING—China's hoard of foreign-exchange reserves shrank in May under pressure from a rising dollar, snapping two months of gains and reviving concerns about the economy's vulnerability to money leaving its shores.

Reserves last month fell by $27.93 billion to $3.192 trillion, erasing $17 billion worth of gains in March and April, central bank data released Tuesday showed. As reserves fall, China's soaring debt and flagging growth heighten the risk for capital outflows.

"Capital outflow pressures likely revived in May alongside the renminbi's 1.6% depreciation against the U.S. dollar, though the scale of outflows should have been limited by the ongoing tightening of capital controls," UBS economist Ning Zhang said. The renminbi is another name for the yuan.

An estimated $25 billion left China's shores in April according to the Institute of International Finance, marking the 25th consecutive month of net outflows. Larger volumes, est imated at around $32 billion according to Capital Economics, are likely in May.

The briefly resurgent dollar also underscores how the Chinese currency still closely tracks the greenback despite Beijing's measures to loosen the peg. Bouts of dollar strength compound a difficult balancing act for Beijing: the government must supply enough credit to revive the economy, yet avoid weakening its currency to the degree where the central bank would have to spend heavily to defend the yuan.

Beijing has some reprieve. A weaker-than-expected May jobs report from the U.S. has doused expectations the Federal Reserve will raise interest rates[6] t his month. Economists say an increase in July is possible but unlikely.

Outflow levels have become more manageable than at the end of last year, when reserves fell by a record[7] $107.9 billion in December as investors rushed to swap yuan for dollar-denominated assets. Capital outflows totaled about $680 billion in 2015.

These outflows, now into their third consecutive year, have become a chronic and highly visible symptom of the weakest economic conditions in the Middle Kingdom in nearly three decades. Large doses of new credit are failing to stoke China's broad economic indicators, including industrial production and retail sales.

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A massive injection of credit early this year took China's broadest measure of money supply, M2, up 14% in January, beating the government's own target for the year and posting the indicator's largest increase since June 2014. Ample liquidity has kept M2 levels high in subsequent months.

Comparing broad money supply to foreign reserves provides clues to an economy's exposure to the risk of capital flight. The lower the reserves-to-M2 ratio, the higher the likelihood of capital flight. In China's case, the reserves-to-M2 measure has fallen to 14.6% in April from 19.2% a year earlier and 22.5% two years ago. May data for M2 are scheduled for release on Friday; economists expect an increase that will outpace April's.

Businesses and investors say Chinese regulators took steps last year to tighten control over funds leaving its borders[8], including limiting how much money Chinese bank-card holders can withdraw abroad and making it harder to buy overseas insurance policies. However, the government has said it didn't impose any new controls and doesn't believe such controls fit its "strategic direction."

Beijing is also trying to diversify more of its reserve assets to lessen its dependence on the dollar. The central bank said last month its holdings of gold reserves in April rose to 58.14 million ounces, or about 1,808 metric tons, up 1.7% from the start of the year. Official gold holdings have risen or held steady every month since June 2015. Economists estimate about half of China's foreign-exchange stockpile is denominated in dollars; much of the rest is in yen and euro.

Write to Chuin-Wei Yap at chuin-wei.yap@wsj.com[9]


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