China’s fx reserves fell to, a still very substantial, USD 2.9982tn in January. Although the largest reserves globally, the dip through the psychological USD 3tn threshold has shaken some market players, despite the same commentators saying that the country’s reserves were too large back when they stood at ~USD 4tn! What the reserves are made of only Chinese officials know, however the drop in reserves, albeit attributable to renminbi protection, is also caused by huge currency swings, or fx valuations. Since June last year, sterling alone has fallen 12.6% against the onshore renminbi, and 16.5% against the dollar, at time of writing.
As Chinese policymakers strive to choke previously untargeted capital outflows, it has been necessary to support the renminbi against the newly expanded CFETS basket. Positive steps to reform monetary and fiscal policy, whilst controlling financial risks and cracking down on corruption has driven ‘hot money’ away from the mainland. Of course this is currently a concern, and as such Chinese policymakers are having to inject foreign currency into the domestic market to support the renminbi. However, there is not an endless stream of hot money funds, as such we expect the rate of outflow to slow; thus fewer reserves deployed. In any case, what are reserves useful for if not to defend a currency during periods of volatility?
So what is enough? The IMF’s adequacy measure calculates USD 2.6tn-2.8tn is adequate. But some argue that having sufficient reserves to cover a country’s short-term external debts, or three months of imports is enough. The most recent figures from SAFE show China’s 3-month imports are ~USD 400bn while short-term foreign debt stands between USD 800-900bn; so there's multiples of reserves available on this basis. With the renminbi now classed as a reserve currency, will it need to hold any reserves at all? After all the uncertain US, and fragile eurozone hold only ~USD 116bn and USD 344bn worth of reserves respectively, according to the most recently published figures.
Of course there are concerns that the PBoC will continue to shield the renminbi from the depreciation trade, but this in effect proves that it does not wish to have a weaker currency, as suggested by the leader of the free world. Our long term view is that the renminbi will appreciate against the dollar, euro and sterling etc. so with such vast reserves, why not sell them at these levels?