China recorded money outflow while foreign reserve fell12 July, 2012, 17:10. Posted by Zarathustra
As implied from the data from the monetary statistics and trade figures, capital outflow appears to have persisted. The position for FX purchase increased by RMB49 billion in June. Taking June’s trade surplus into account, that implies an outflow of about RMB153 billion, although the sources of this apparent outflow cannot be identified based on these numbers alone. It could be a manifestation of slowing foreign investment, hot money outflow and US dollar short covering (which is not outright outflow). The current trend of apparent outflow is already considerably worse than the previous crisis in 2008/2009.
Meanwhile, the continued weak flow feeds into China’s foreign reserve. As we mentioned in our guide to China’s monetary policy, trade surplus and inflow forced the Chinese central bank to create Chinese Yuan to prevent it from appreciating too quickly, thus creating permanently excessive liquidity within the banking system. The other side of the money creation is the increased of central bank’s balance sheet, with the FX reserve on the asset side increasing. The opposite will happen if trade surplus decreases and inflow becomes outflow.
Due to such trend, China’s foreign exchange reserve has already stopped growing since the second half of last year. FX reserve has fallen by US$64.966 billion since last disclosure (Q1 end), while the year-on-year growth rate has fallen to 1.3% in both May and June, which appears to be the lowest year-on-year growth rate on record.
Source: People’s Bank of China
The weakening flow situation implies that the massive foreign exchange intervention is no longer necessarily, thus the growth in China’s FX reserve fell to record low. However, it implies that the other side of the central bank’s balance, i.e. currency issuance, will be slowed as well. As a result, we believe liquidity condition within Chinese banking system will be tight relatively to the past if the current trend continues, and this will necessitate more aggressive cuts of reserve requirement ratio in the near future.