Chinese FX Reserves fell for a fourth consecutive month in February, dropping US$30.9 billion to US$3.2 trillion.
The decrease left the nation’s FX reserves at lows not seen since December 2011, although the pace of decline was the slowest seen since October last year. It was also in line with market expectations.
Over the 12 months to February the value of reserves dropped by US$601.5 billion, the largest amount on record.
While the decline suggests that capital outflows may have slowed, weakness in the US dollar may have also contributed to the sharp deceleration seen in February.
Richard Grace, chief currency and rates strategist at the CBA, explains the relationship between the US dollar and the valuation of Chinese reserves.
“The large non-USD share of China’s foreign exchange reserves means that a rise in the US dollar will, by definition, generate a large valuation decline in almost half of China’s foreign exchange reserves,” says Grace. “When the USD rises, China’s reserves decline.”.
“According to the calculations in China’s quarterly balance of payments data, some 44% (US$291bn) of the US$663 decline in total foreign exchange reserves since the end of December 2015, has been entirely due to valuation effects.”
Essentially, because China’s FX reserves are measured in US dollar terms, its fluctuations have a large bearing on the value of China’s non US dollar denominated currency reserves.
The chart below, supplied by CBA, explains what Grace is saying in visual form.
Up until recently the US dollar was rallying on expectations of further rate increases from the US Federal Reserve, helping to boost the US dollar index. As it rose the level of China’s FX reserves fell, partially due to capital outflows but also valuation effects.
That wasn’t the case in February. The US dollar weakened as markets all but priced out the likelihood of further rate hikes from the Fed this year, helping to increase the value of non US dollar denominated assets, including part of China’s FX Reserves.
While the deceleration in February won’t be enough to appease many China bears, as Grace suggests, much of the decline seen in recent months was just as much about revaluation effects as it was about capital outflows.
The outlook for US monetary policy, and as a consequence the value of the US dollar, will continue to play a major role in determining capital movements and the level of Chinese reserves in the months ahead.