August 7, 2018 / 9:34 AM / in a month

UPDATE 1-China July FX reserves rise to $3.118 trln despite trade tensions

* July FX reserves rise $5.82 bln vs expected drop of $12.1 bln

* Asset swings, non-dollar FX changes behind reserve rise - SAFE

* Trade tensions weigh on yuan, capital fight closely watched (Adds details, comment)

By Kevin Yao and Fang Cheng

BEIJING, Aug 7 (Reuters) - China’s foreign exchange reserves unexpectedly rose in July even as worries over escalating trade tensions between the United States and China have caused market volatility.

Changes in China’s foreign currency holdings are closely watched by investors for any signs of capital flight, as rising trade tensions have hit Chinese stocks and the yuan currency.

Reserves rose $5.82 billion in July to $3.118 trillion, compared with a rise of $1.51 billion in June, central bank data showed on Tuesday.

Economists polled by Reuters had expected reserves to drop by $12.1 billion last month to $3.100 trillion.

The July reserves “point to continued inaction by the People’s Bank (PBOC),” Julian Evans-Pritchard at Capital Economics said in a note.

“The fact that headline reserves moved in the opposite direction doesn’t mean the PBOC purchased FX last month to push down the value of the renminbi. More likely, the increase simply reflects valuation effects from a rise in the price of the foreign bonds held by the PBOC,” he said.

Financial asset fluctuations and changes in non-dollar currencies lead to the small rise in China’s foreign exchange reserves, the State Administration of Foreign Exchange (SAFE) said in a statement.

During July, the dollar index that measures it against other major currencies fell 0.2 percent.

The yuan has fallen 6.3 percent against the dollar since June 14, due to escalating trade tensions with the United States, and that has fanned fears of capital outflows. In 2017, when there were substantial outflows, China imposed tighter capital controls.

The yuan weakened for a fourth straight month in July, the longest such streak since early 2015.

COUNTER-CYCLICAL MEASURES

On Friday, China’s central bank said it would set a reserve requirement ratio of 20 percent for financial institutions settling forward dollar sales to clients, effectively raising the cost for investors shorting the yuan.

The People’s Bank of China said it would take counter-cyclical measures to keep foreign exchange markets stable.

Before that move, China’s uncharacteristically laissez-faire approach to its swiftly declining currency had spawned market speculation that the yuan was part of an economic stimulus toolkit and would be allowed to weaken more during the rest of the year.

The central bank also said raising forex settlement reserve requirements is a transparent, non-discriminatory, price-based prudential policy tool, not a capital control.

“If the PBOC tolerates a much weaker currency, severe 2015-like capital flight will again become an immediate risk, which could bring about a market chaos,” Zhou Hao, senior emerging markets economist at Commerzbank, said in a note to clients on Friday.

The value of China’s gold reserves fell to $72.324 billion at the end of July, from $74.071 billion at the end of June.

Editing by Richard Borsuk

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