HONG KONG (Reuters Breakingviews) - China's forex reserves have fallen below $3 trillion for the first time in nearly six years in January. The rate of contraction has slowed as China closes up its capital account, but for a country obsessed with symbolic numbers, targets, quotas and index levels, a worrying line in the sand has been crossed.
The ongoing shrinkage in China's foreign cash stash is partly due to attempts to defend another line in the sand, namely keeping the exchange rate above 7 yuan per dollar. Having intervened heavily offshore to hold this line in January, the People's Bank of China is now compelled to defend it whether it makes sense or not. In the background is a U.S. Treasury report due April in which China could be labelled a currency manipulator.
Much depends on the dollar itself. If the long-running dollar rally is nearing its peak, Beijing can relax. Losing less than $13 billion a month from foreign reserves isn't threatening; China has almost $400 billion to burn through before it closes on the critical $2.6 trillion level – roughly the minimum China would require under International Monetary Fund guidelines.
Unfortunately few economists believe the yuan is anywhere near market bottom, calling for further slides of 5 percent or more this year. Were China to leave the yuan’s value entirely to market forces, it would probably result in a sharp drop. That would in turn accelerate capital flight, and invite U.S. retaliation. The absolute level of China’s reserves is not yet concerning – but the direction of travel might be.
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