China will see over $700 billion (£487 billion) of capital pour out of the country in 2016, according to Goldman Sachs.
But the bank says there’s no need to worry that continuing outflows will lead to a currency crisis any time soon.
In a massive new note addressing the concerns of investors about China’s currency, the renminbi, Goldman says that while capital outflows from China have increased since 2013, one of the biggest concerns investors have right now — the fall in FX reserves — isn’t a huge issue yet.
One of the biggest concerns when it comes to China is the massive slide in the amount of money being held in foreign currencies by the People’s Bank of China.
In the past couple of years, the bank has been burning through its massive currency piles at some of the fastest rates in history, partly due to a massive programme of buying US dollars to prevent the renminbi from weakening further.
In February, the PBOC announced the biggest single monthly drop in currency reserves in the country’s history, and reserves are now well below their 2014 peak of more than $4 trillion (£2.78 trillion), and still falling — although at the latest release, the rate at which reserves are being expended fell.
That fall in foreign currency held in China has led some to predict a coming currency crisis in the country, but Goldman Sachs isn’t too worried about that right now, saying that on virtually all measures, currency reserves are at what they call a “comfortable level”. Here’s Goldman on some of the most commonly used metrics (emphasis ours):
- Import cover: Defined as the number of months imports can be sustained should all inflows cease. The IMF uses three months’ import coverage as the benchmark for reserves. China’s FX reserves cover 22 months of imports.
- The ratio of reserves to short-term debt: This is the most widely used metric for reserve adequacy and is known as the Greenspan-Guidotti rule. It specifies that reserves should cover 100% of short-term debt. On the latest available information, China’s FX reserves comfortably cover short-term external debt, by over 300%.
- Composite measures: The IMF has sought to aggregate several measures of reserve adequacy in order to capture a range of risks. The Fund has proposed a measure that includes short-term debt, portfolio liabilities, export income and broad money, and that also accounts for each country’s exchange rate regime. Reserves in the range of 100-150% of this metric are considered broadly adequate for precautionary purposes. At the moment, China’s reserves fall in this 100-150% range.
Goldman’s view contradicts that of Barclays’ analysts Ajay Rajadhyaksha and Jian Chang, who are convinced that China has entered a “zugzwang” when it comes to FX reserves, and could have as little as six months before reserves fall below what Barclays describes as comfortable levels.
It’s also against the beliefs of Societe Generale’s notoriously bearish strategist Albert Edwards, who, in February said that China is running out of money and that falling FX reserves will force the country into floating the renminbi in the near term.
While Goldman is fairly bullish on the future of China’s currency reserves, it does point to concerns in one area, that of so-called “broad money” or M2. Broad money is a metric “designed to capture the risk of domestic sales of local currency assets” and includes not just physical cash, but also deposits held in banks and cash held in mutual funds.
Goldman says that China’s broad money situation isn’t great, with reserves covering just 18% of broad money. The IMF recommends that at least 20% should be covered. Here’s the chart:
So while Goldman isn’t hugely worried about the foreign exchange situation in China just yet, the bank does warn, in the header of one chart that reserve rates are “approaching the lower end of the adequacy range.” Here’s that chart:
What happens going forward is unclear, but there’s no need to panic yet.