The People’s Bank of China, the central bank, reported that Beijing’s foreign exchange reserves rose $11.4 billion last month. The increase marked the end of five months of consecutive declines.
The addition to the reserves, after months of record capital outflows, took the financial community by surprise.
As the Wall Street Journal notes, “reserves are a proxy for capital inflows and outflows.” During the month, net capital flow, as calculated by Bloomberg, was $62 billion outbound. Even though Bloomberg counts money left by Chinese parties in dollars as outflow, it is nonetheless not possible to reconcile its figure with the reported increase in reserves.
More technically, changes in the reserves over time have tracked the foreign currency position of banks. As Bloomberg reports, “policymakers buy or sell reserves to partially offset capital flowing in and out of the nation.”
Here, Beijing’s official reporting becomes “mysterious,” as a leading American academic told me last week. The State Administration of Foreign Exchange, the central bank unit administering the reserves, reported that Chinese banks in October sold a net 190.9 billion yuan ($30.0 billion) of foreign exchange for clients. That number should more or less match the change in reserves for the month, but there is a $41.4 billion discrepancy that is, on its face, inexplicable.
Yet there is an explanation. Beijing is apparently resorting to derivative transactions to relieve the necessity of draining its reserves.
China’s large state banks have been borrowing dollars in the swap market, then selling the greenbacks in cash markets, and finally hedging their dollar exposure by entering into forward contracts with the PBOC. That, Goldman Sachs noted, means the central bank is taking the commercial banks’ positions onto its own balance sheet. This maneuver allows Beijing to support the renminbi without causing an immediate decline in the reserves.
The scale of the transactions is not small. The central bank and local lenders increased their holdings of onshore forwards to $67.9 billion in August, a figure five times larger than the monthly average for the January-July period.
At the same time, the central bank is going to great pains to hide its tracks. “My greatest frustration is with the highly untransparent and randomly changing balance sheet data” of the central bank, Victor Shih of the University of California, San Diego told the Quartz website. The PBOC is stuffing more transactions into murky categories such as “other foreign assets,” “other assets,” and “other liabilities.”
And given the obvious intent to mislead, we cannot dismiss the possibility that the central bank has also engaged in outright misreporting. For one thing, the scale of the defense of the renminbi may be too large to hide, even in the obscure figures that Shih complained of.
In addition to the large discrepancy for October noted above, there is a gap for the third calendar quarter. During Q3, net capital outflow as calculated by Bloomberg—$460.6 billion—dwarfed the reported fall of the reserves, $179.7 billion.
It cannot be a coincidence that in recent months the officially reported declines in China’s reserves have consistently come in at less than consensus estimates.
The Wall Street Journal reported that sources “close” to the People’s Bank of China revealed that the bank’s “internal estimates” show the institution in August, when it devalued the renminbi, sold between $120 billion to $130 billion to defend the currency. The Financial Times reported $200 billion, and that figure, not coincidentally, was the consensus estimate of a Reuters poll for the fall in the reserves that month. Yet the central bank reported that the country’s foreign exchange reserves fell only $93.9 billion that month.
August was not an anomaly. Economists polled by Bloomberg expected the reserves to fall by $57 billion in September. The central bank, however, reported a decrease of only $43.3 billion.
Beijing will require ever larger amounts to prop up its overvalued currency. Yes, it was able to stabilize perceptions last month, helped in part by news that the International Monetary Fund would include the yuan in the basket for its Special Drawing Rights, but neither Beijing nor the IMF will be able to prevent the downward movement in the Chinese economy from accelerating. And as the economy continues to deteriorate quickly, the central bank will have to spend greater amounts in defense of the “redback,” even if the Federal Reserve does not begin raising interest rates soon.
“The current ‘market’ tells you nothing because it is so manipulated,” Fraser Howie, the co-author of the acclaimed Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise, told me last week, referring to trading in the yuan. Despite its August pledge to allow the currency’s value to be more market-driven, Beijing looks to have been moving in the opposite direction and therefore needing to spend more foreign exchange. And its defense costs have gone up also because it is for the first time intervening in offshore currency markets as well as its domestic one.
In any event, the renminbi is under a rather large dark cloud. Eventually, China’s central bank will have to close the derivative positions it took on to hide its defense of the currency. Brazil in 2013 used the same stratagem to shore up the real, and that maneuver eventually ended with the currency plunging when forward and swap positions were unwound.
The State Administration of Foreign Exchange reported that at the end of October, the country was holding forex reserves of $3.53 trillion. Yet taking into account the PBOC’s short positions in the dollar, the figure is, my guess, only $3.1 trillion.
Whatever the real amount is now, trust me, you do not want to be long renminbi when China’s central bank finally closes out its forwards.
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