China’s official reserves slipped to $3.18 trillion in the final quarter of 2011, signalling that the days of rampant export-led accumulation of foreign currency are numbered and that new monetary policy steps may be needed to counter capital outflows.
The People’s Bank of China published data on Friday showing a $20.6 billion, or 0.6 per cent, fall in reserves in the final three months of the year, though Beijing’s stash of foreign wealth is still by far the world’s largest.
Reserves dropped in November and December, the first consecutive monthly fall since the first quarter of 2009, a clear sign of the impact that a falling trade surplus and an outflow of speculative funds is having on China’s capital flows.
And while the quarterly fall does not signal massive capital flight from China, analysts say it does argue for Beijing to further lower the amount of cash it makes banks hold as reserves to ensure sufficient market liquidity.
“The decline in foreign exchange reserves in Q4 is consistent with the sharp reversal in capital flows out of emerging markets in general and the region in particular,” said Andy Ji, an economist at Commonwealth Bank of Australia in Singapore.
“The People’s Bank of China is likely to engage in more cuts in the reserve requirement ratio (RRR) and aggressive liquidity injection through open market operations if the trend deteriorates further,” he said.
Falling export demand
China lopped 50 basis points from a record high RRR of 21.5 per cent at the end of November, the first cut in three years as it sought to shield its economy from falling export demand from debt-ridden Europe and lethargic US consumers.
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Economists polled by Reuters expect China to cut 200 bps from RRR this year, anticipating more sluggish export growth.
Data this week showed Chinese exports growing at their weakest pace in more than two years in December, helping shrink China’s 2011 trade surplus to a three-year low of $155 billion.
Bank of America-Merrill Lynch Economist, Ting Lu, expects a trend of sinking surpluses to retard capital flow into China, necessitating a policy response to keep economic conditions as stable as possible ahead of a change in the country’s top political leadership anticipated in late 2012.
“The drop in foreign currency inflow will have significant implications for China’s monetary policy, but limited impact on liquidity conditions if policymakers are flexible in using monetary tools,” Lu said, adding that he expects more reserve requirement cuts.
"Chinese policymakers will be reluctant to see any risk of a capital flight in 2012 as they seek for stability during leadership change, " he said.
Separate data showed China may have experienced a third month of capital outflows in December after the central bank and commercial banks sold a net 100.3 billion yuan ($15.9 billion)worth of foreign exchange in December.
HUGE RESERVE RISES "HISTORY"
The drop in China’s reserves may start to appease some critics who say they are a product of an economy reliant on an under-valued yuan for export-driven growth.
The median forecast by economists was for China’s foreign exchange reserves to have held steady at the end of December from the end of the third quarter.
China reserves are the largest in the world, largely due to the central bank’s sterilization of dollar inflows into the country’s closed capital account.
But some analysts noted that increasing use of the yuan in trade settlements would also help slow China’s future build-up of foreign currencies.
"Foreign exchange reserves may rise further in a long term view" but the era of sharp increases is "history", said Hua Zhongwei, an economist with Huacheng Securities in Beijing.
In the third quarter of 2011, foreign exchange reserves rose just $4.2 billion to a record of $3.2 trillion. The pace was markedly slower than a $152.8 billion rise in the second quarter. ($1 = 6.3178 Chinese yuan)
(Additional reporting by China Economics Team; Editing by Richard Borsuk)