The latest figures on China’s foreign exchange reserves showed a significant deceleration in their decline. Abating from an average outflow of $98bn per month in the prior 3 months, February’s smaller $28.6bn outflow raises questions on whether recent concerns were themselves overheated. One questions whether extrapolating the trend of recent months into multiple years aligns with the underlying causes of such flows and their likelihood of persisting - at such levels and for prolonged periods. Such assumptions are necessary for outflows to sufficiently dent China’s monumental reserves and ability to defend its long term goals. Such assumptions are proving ever more doubtful. This forthcoming month’s results should help evaluate the important factors and help affirm any possible trend changes.
China’s FX reserves now stand at $3.2tn, down from £4tn in mid-2014. Factors such as the cash hoarding traditions of Chinese New Year (where the traditional reply to “Happy New Year” is “Hong Bao Na Lai” meaning "May I have the red [money] envelope, please") may have distorted this month’s smaller decline. But evidence suggests that multiple causes of these outflows have receded and the most significant avenue for flows has been constrained - namely the government crackdown on over-invoicing of imports, estimated to comprise around 80% of the outflows, has finally started gaining traction.
Furthermore recent developments, including further opening up of the Chinese $7.3tn domestic bond market, could prove a significant driver of foreign investment flows – especially considering China’s internationally eschewed but now relatively attractive bond yields and equity P/E ratios. Also Chinese foreign direct investment and paying down of dollar debts are expected to slow in coming quarters. All of these factors affecting reserves are showing signs of slowing down and some could soon see a change in direction. Markets are wise in endeavouring to pre-empt distresses but - with China’s reserves still larger than the combined reserves of: Japan, Eurozone, Korea, Germany, UK, France and the US - the recent hyperbole of concerns failed to consider just how long term recent shocks were likely to last.
Highlights from the recent liberalisation of China’s interbank bond market (CIMB) typify the many ongoing reforms towards capital market liberalisation. It is one of many reforms that have not been so notoriously miscommunicated and have consequently received scarcer market consideration - when in fact they pose a significant impact and opportunity. CIMB accounts for over 90% of RMB bond issuance and trading. It is over 50 times larger than the currently more accessible Dim Sum market. Following the PBoC’s announcement on the 24th February 2016 practically all investors will be able to access the onshore market. Previous quotas will be dropped and a breadth of long term institutional investors, who will no longer be constrained from buying this market, will have to decide whether to increase their allocation to China before or after everyone else does.
Currently foreign ownership of Chinese bonds represents only 2.6% of the total, compared to 57% in Mexico and 38% in Brazil. Even in absolute terms the international market currently holds over 30% more Polish debt than Chinese debt despite China’s economy being 20 times the size of Poland’s. Likewise foreigners only hold around 2% of Chinese government bonds compared to Japan (10%), UK (26%), US (42%) and Germany (60%). The concerns over the potential for increasing outflows now seem disproportionately large whereas current positioning and expectations for potential foreign inflows to China seem disjointed and disproportionately senseless. China has a larger population than all of North America, South America and the Eurozone combined. At the very least one should reassess any pessimism towards the China narrative in the light of recent developments and data - not forgetting its scale, its 40 years of relatively successful reform and how underinvested most of the western world is there.