China forex reserves down from 40% of money supply to 10%


Last week, the People’s Bank of China injected cash totaling 810 billion Chinese yuan ($122.4 billion) in five straight days of daily liquidity management operations. Those actions, which represented the largest weekly net increase since January, were in part a Beijing response to its 10-year sovereign bond yields spiking to multiyear highs, experts said. Nomura analysts said last week in a note that the bond rout was due to fears of regulatory tightening from Beijing. Bond yields, which move inversely to prices, briefly hit 4% in China for the first time in three years.

With the foreign exchange reserve being relatively fixed, foreign exchange reserves as a share of money supply have fallen from 40% just five years ago to 10% today,” Victor Shih, a professor and China expert at UC San Diego, told CNBC.

The foreign currency reserve is a primary tool for managing currency values — an important issue for China — and the increasing base of liquidity should continue to dilute its power, Shih added. Over time, as the ratio declines, it will get harder for the FX regulator to counteract capital flight: Beijing keeps money in its system (and the yuan strong) by buying up its currency in international markets with its horde of foreign cash. So if there’s more RMB to buy, then the reserves won’t go as far. Shih suggested such a situation could eventually “wipe out” the reserves entirely.

That would leave Asia’s largest economy exposed to outside shocks. “That is a great weakness of China, it’s something external, especially if we have things like multiple rate hikes in the Federal Reserve,” Shih said.

With M2 in China being 3x the US as a percent of GDP, $3 trillion in forex reserves suddenly doesn’t sound like a lot of money.

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