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Investors buckle up for expected drop in China's forex reserves
September 4, 2015 / 8:23 AM / 2 years ago

Investors buckle up for expected drop in China's forex reserves

BEIJING, Sept 4 (Reuters) - Global investors are bracing for data next week that could show a big drop in China's foreign exchange reserves as the central bank steps up its intervention to stabilise the yuan currency after its shock devaluation last month.

China has been so surprised by the global market reaction to its devaluation that it is likely to keep the yuan on a tight leash in the near-term to head off fears of a global currency war, policy insiders told Reuters.

But many traders believe there is political pressure to allow a deeper depreciation in coming months as the world's second-largest economy slows.

China's foreign exchange reserves, the world's largest, have been falling from a record $3.99 trillion in June 2014 due to a wave of capital outflows fuelled by jitters about its economic slowdown and an expected move by the U.S. Federal Reserve to raise interest rates.

Foreign exchange reserves fell by $42.5 billion in July to $3.65 trillion, the sharpest monthly drop since March.

The decline appeared to have quickened after China's near 2 percent devaluation of the yuan on Aug. 11 stoked fresh concerns about its economy. The move sparked heavy selling of the yuan, and the central bank has intervened repeatedly since then via state banks to sell dollars to shore up the currency.

Analysts at Barclays Capital estimate the People's Bank of China (PBOC) stepped up its foreign exchange intervention to $122 billion in August from about $50 billion in July.

"If the current pace of FX intervention continues, we estimate that the PBOC could lose up to around 14 percent of its FX reserves (ex valuation adjustments) between June and December," Barclays said in a research note.

"We estimate the PBOC would have to reduce the reserve requirement ratio by around 40 basis points a month just to offset the impact of its FX operations on domestic liquidity."

Moreover, much of the money released into the economy by cutting banks' reserve requirements may merely replace funds being moved offshore, rather than finding its way into new loans to companies which would support the real economy.

"We do not believe the present policy is sustainable given the associated costs in terms of FX reserves depletion and liquidity imbalances," Barclays said.

"As such, we maintain our view that the yuan will need to depreciate further to stabilise capital outflows; we forecast a further 7 percent fall by year-end."

A Reuters poll on Friday showed strategists expect the yuan to weaken another 2 percent in six months, though some were more pessimistic and predicted it would dive to 6.80 in 12 months from around 6.35 on Friday.

Nomura said on Thursday that intervention in August could be around $170 billion, an unprecedented amount for just one month.

Analysts at Dutch bank Rabobank estimated that China sold up to $200 billion of reserves in the last few weeks of August alone.

Central banks will sell $1.5 trillion of forex reserves by the end of next year as they try to counter capital outflows stemming from China's slowdown, low oil prices and a rise in U.S. interest rates, Deutsche Bank said on Tuesday.

That would mark a major shift in global capital flows, ending two decades of reserve accumulation by emerging markets.

The PBOC in July shifted to reporting its foreign exchange reserves monthly from a quarterly basis.

Reporting by Judy Hua and Kevin Yao; Editing by Kim Coghill

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