Date
28 March 2017
The governor of Japan's central bank warned that China should strengthen its capital controls, instead of using foreign reserves, to maintain the stability of the renminbi. Photo: Bloomberg
The governor of Japan's central bank warned that China should strengthen its capital controls, instead of using foreign reserves, to maintain the stability of the renminbi. Photo: Bloomberg

China’s foreign reserves not enough to defend renminbi

The People’s Bank of China (PBoC) injected a net 210 billion yuan (US$31.9 billion) into the financial system Tuesday, on top of the combined 1.85 trillion yuan it injected last week.

The mainland is clearly experiencing tight liquidity.

It seems the PBoC has made renminbi stability its top priority and may launch more measures to defend the exchange rate.

Analysts said the central bank won’t allow a sharp devaluation of the currency, because that will lead to increasing capital outflows.

Moreover, as the International Monetary Fund has decided to add the renminbi to its special drawing rights currency basket, the Chinese government should work to maintain the world’s confidence in the renminbi.

Foreign reserves are a necessary tool to keep the exchange rate stable.

China recorded a US$595 billion trade surplus in 2015, but its foreign exchange reserves fell by US$513 billion, indicating the huge cost of keeping the renminbi exchange rate stable.

The drawing down of the foreign reserves can create a stable environment for economic growth, but is it cost-effective?

Bloomberg estimated, using the IMF’s foreign reserve standards, that if China had effective capital controls, it would need only US$1.8 trillion in foreign reserves.

In other words, the country can use US$1.5 trillion of its US$3.3 trillion in foreign reserves to defend the renminbi exchange rate.

But what if China loses control over capital flows?

Then, to be safe, it should keep US$2.9 trillion in foreign reserves.

Assuming outflows continue at their current speed, China’s foreign reserves will drop below the IMF’s security line by the middle of this year.

All in all, the PBoC’s decision to maintain the stability of the renminbi has been welcomed by global investors.

But if renminbi outflows accelerate, the country’s foreign reserves will come under pressure.

The governor of Japan’s central bank warned at the Davos Forum in Switzerland that China should strengthen its capital controls, instead of using foreign reserves, to maintain the stability of the renminbi.

We believe that may be the right solution.

This article appeared in the Hong Kong Economic Journal on Jan. 27.

Translation by Myssie You

[Chinese version中文版]

– Contact us at [email protected]

MY/JP/FL

Department of Investment Analysis at HKEJ

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