Vicious cycle of more outflows and currency depreciation looms large.
Singapore: As China’s foreign exchange reserves threaten to tumble below the critical $3 trillion mark, the biggest fear for investors is not whether Beijing can continue to defend the yuan but whether it will set off a vicious cycle of more outflows and currency depreciation.
Data this week is expected to show China’s forex reserves precariously perched just above $3 trillion at end-December, the lowest level since February 2011, according to a Reuters poll.
While the world’s second-largest economy still has the largest stash of forex reserves by far, it has been churning through them rapidly since August 2015, when it stunned global investors by devaluing the yuan and moving to what it promised would be a slightly freer and more transparent currency regime.
Since then, authorities have repeatedly intervened to support the yuan when it weakened too sharply, burning through half a trillion dollars of reserves and prompting them to sell some of their massive holdings of US government bonds.
They also have put a tightening regulatory chokehold on individuals and businesses who want to move money out of the country, while denying they were imposing new capital controls.
Concerns over the speed with which China is depleting its ammunition are swirling, with some analysts estimating it needs to retain a minimum of $2.6 trillion to $2.8 trillion under the IMF’s adequacy measures.
“There has been quite a bit of anxiety and speculation because the way many people in China talk about it is ‘will the government defend the 7-per-dollar level or the 3 trillion dollars’,” said Louis Kuijs, head of Asia economics at Oxford Economics in Hong Kong.
China stepped into its onshore and offshore yuan markets this week to shore up the yuan as it neared the 7 level, sparking speculation that it wants to regain a firm grip ahead of the Jan. 20 inauguration of Mr Trump, who has threatened to brand Beijing a currency manipulator. But if forex reserves continue to be depleted at a fast pace and capital flight continues, some strategists believe its leaders may have little choice but to sanction another big “one-off” devaluation.