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China’s Foreign Exchange Reserves Shrink in July
By Isaac Ndegwa
China has for a long time been getting many plaudits because of its vast foreign exchange reserves. It has always been considered a bullish pointer because the country is expected to remain strong whenever there are economic headwinds facing the rest of the world. However, China is currently undergoing a catch-22 situation as it wants to embark on expanding the domestic money supply to boost the banking system’s ability to rolll over the existing bad debts. Foreign exchange reserves fell to $3.2 trillion in July
Data released in August shows that over the month of July, China’s foreign exchange reserves fell to $3.2 trillion. The figure is $4.1 billion dollars lower than that of June. Typically, a decreasing exchange reserve level if compared to the expansion in domestic cash supply would normally mean insufficiency in the capital outflows. The figures are however better than had been expected according to some market participants. They suggest that the exchange reserves, even if dwindling, are still very healthy compared to other countries if they are looked at relative to the country’s GDP and the rest of its balance of payment.
There has been a somewhat alarming fall in the ratio of reserves to the money available for local supply. The ratio (M2) has been at its lowest level since 2014, now showing 14% whereas it was 27% in June 2014. The IMF recommends a level of 20%. There have been projections of lower capital outflows mostly due to China’s own valuation of a weaker US dollar. That still flatters its timing to boost the money available to local banks and state borrowers who are often handle the biggest transactions involving capital outflows. Analysts recon that the situation would ultimately mean weaker returns on investment, less productivity and more pressure real rates in the coming months.
Bullish projections still remain intact
On the bright side, having a lower holding of Forex reserves sometimes means that the country will be able to weather the storm if the dollar continues to decline further. They would be holding less of currencies that are in decline if the weakening dollar is put into perspective. As long as the economy can be able to meet the balance of payments with the existing level of foreign exchange reserves, there is less need for alarms. The bullish projections of China’s FX reserve adequacy does not suffer much. Hard policy choices will however need to be made purely on the back that there had been plans to boost the flow of money to the banking sector.
China has so far made a good show in trying to avoid sharp depreciation in the exchange rate. Depreciating exchange rates traditionally fuel capital outflows in the country resulting in tightened domestic liquidity whenever it happens. It is apparent that they need to play a special balancing game to avoid too much depreciation while still not keeping the appreciation rate to high to the point where relaxed monetary policies impend the growth levels.
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By Isaac Ndegwa
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