China’s FX reserves stabilized for the third month running, in a sign that China has made some serious headway in tightening capital controls. The top chart shows that PBoC selling of FX reserves has not been significant since January this year. The bottom-left chart shows the capital and financial account, on a 4Q sum basis, is now in surplus for the first time since 2001. Normally when China clamps down on its financial account, leakage increases through the current account, either through export under-invoicing, or import over-invoicing. But as the bottom-right chart shows, after a rise in this activity, it has fallen back fairly sharply.

This is good news for China as it takes pressure off the currency and aids overall macroeconomic stability. However, there are several developments that could lead to volatility in China. The PBoC is tightening liquidity, leading to a flattening of the yield curve, which points to weaker growth. High inflation is squeezing excess liquidity lower, which points to weaker asset prices. And there is a concerted effort to rein in shadow banking.

Source: Bloomberg, Macrobond and Variant Perception