Investors welcomed the vow made last year by the new Chinese government to reform the economy through a clamp-down on shadow banking and excess liquidity as well as to commit to a strategy of re-balancing the economy. Still, it seems difficult for China to break out of its old ways. Data released this week consequently shows FX reserve growth in China surging towards the end of last year.
China’s swelling foreign-exchange reserves, reported today to have reached a world record $3.82 trillion at the end of December, may sustain the nation’s appetite for U.S. debt. Capital inflows and intervention to limit gains in the yuan have contributed to China building up currency holdings that are a third of the global total.
China’s reported FX reserves has swelled in the past 6 months and will surpass $4 trillion this year if the growth rate continues.
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This comes after widespread reports (and concerns) in the middle of last year that FX reserve growth in China was turning structurally negative and thus that structural capital inflows would start to reverse. Nothing could be further from the truth based on the most recent data.
Annual FX reserve growth (as reported by China) has risen from a trough of 1% in August 2013 to more than 15% based on the most recent data.
Obviously, there is the usual discrepancy between data reported from the Chinese balance of payments and numbers on the US side. However, the growth rate of foreign UST holdings reported in the US is starting to nudge up so we can be relatively confident that this growth is real.
Explanations for this resurgence vary but two theories are worth considering in our view. The first is that that higher rates in China are leading to a carry trade domestically. The liquidity squeeze has thus pushed up rates and incited investors to move money onshore and FX reserves go up.A stronger currency will have helped to attract capital too of course especially in the context of a sharply depreciating JPY and widespread EM FX weakness in 2013. Another explanation is that the tapering scare has benefited China in relative terms along the same lines as it has benefited surplus nations such as South Korea and Malaysia.
What is most interesting to watch this year relative to the explanations above is that they imply a higher volatility in capital flows relative to the more or less steady twin surplus enjoyed by China in recent years. This is an important trend to watch in our view.