Falling China forex reserves follow weaker currency

China’s foreign exchange reserves dropped more sharply than expected in October, falling to their lowest level in more than five years, according to data released by the country’s central bank.

Reserves were $3.121tn, a level last reached in March 2011. The monthly decline amounted to $45.7bn, bigger than economists had forecast, with the scale of drop the largest since January when markets were thrown off course by concerns about China’s economy slowing down and a falling oil price.

Peter Kinsella, emerging markets forex strategist at Commerzbank, said that the decline in FX reserves was consistent with price action during October, when the dollar-renminbi exchange traded around 6.67

The decline is the largest since January and it does point to an increase of capital outflow pressure,” Mr Kinsella said.

Analysts see the PBoC’s monthly reserves data as a proxy for currency intervention, and interpret the central bank’s need to intervene as a sign that it is worried that the renminbi is weakening too far.

Jens Nordvig, chief executive of the analytics consultants Exante Data, said that the scale of central bank FX intervention was a worrying development.

There are notable cracks emerging under the surface: the fairly orderly depreciation of the Chinese currency over the past few weeks has been achieved only in the face of an aggressive currency intervention by the Chinese central bank, Mr Nordvig said.

The renminbi weakened by a quarter of a per cent on Monday, although attention in the FX market is fixed on the US election. The dollar has been strengthening against most currencies as investor expectation of a Hillary Clinton victory strengthens, and the renminbi was not immune from that effect.

While market attention is elsewhere, China has taken a back seat, partly because fears about its economy have stabilised.

This is most graphically illustrated in FX volatility. The renminbi was the source of market turmoil in August 2015 when PBoC reform of FX policy resulted in a sharp decline in the currency.

But its fall since mid-March of nearly 5 per cent has not elicited similar investor concerns, helped by better central bank communication and relatively stable economic data.

Dollar-renminbi currency options are at their lowest in more than a year, said Mr Nordvig, a sign that the market expected stable FX market conditions in China.

However, the US election poses problems for the PBoC, particularly if the dollar rallies further on the back of a Clinton victory and a likely tightening of Federal Reserve policy next month.

Goldman Sachs said that a rising dollar meant that the PBoC had to set a higher fix for trading dollar-renminbi, “which carries the risk of accelerating capital flight.

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