SHANGHAI -- Chinese foreign-currency reserves threaten to dip below $3 trillion, keeping observers on edge for any hint of renewed yuan market turbulence.
The People's Bank of China reports on the nation's reserves as of the end of March on Wednesday or Thursday. The balance stood at $3.2 trillion at the end of February, down $28.6 billion from January and around $600 billion from a year earlier. Spending has likely slowed over the past month. But the psychologically important barrier draws ever nearer.
Calm for now
Pressure in China toward capital outflows is clearly easing, Wang Yungui of the State Administration of Foreign Exchange, or SAFE, said in a March 22 press briefing. The yuan reached its strongest level against the dollar in around three months March 18, signaling that the market has regained composure after a rough start to the year. The central bank's guidance rate for yuan-dollar trading on March 31 had the Chinese currency at its strongest level since Dec. 15.
China has recently used vast amounts of its dollar reserves to buy up yuan and halt the currency's slide, spending around $100 billion a month through January. The falling balance fanned distrust in the economy, inviting further yuan outflows. Only on March 16, when the U.S. Federal Reserve indicated that it would raise interest rates just twice this year, did the yuan regain its footing.
With its Qualified Domestic Institutional Investor scheme, China strictly limits the number of parties it allows to invest abroad. The domestic bond market, on the other hand, has been thrown wide open to foreign investors to help draw in capital from overseas. But as long as prospects are dim for a rapid Chinese economic recovery, a surge in expectations of another U.S. rate hike would likely reignite fears of capital flight. Many market players view the yuan's stability as temporary.
Chinese authorities are thus on high alert for speculative yuan-selling by foreign traders. Famed investor George Soros' comment in January that a "hard landing is practically unavoidable" for China's economy was a particularly sore point. In response, SAFE's Wang said in March that the regulator is studying a Tobin tax, which would penalize short-term speculative trading.
Based on the value of China's trade and other International Monetary Fund indicators, Societe Generale reports that $2.8 trillion is about as low as the country's currency reserves can go without endangering the economy. This level is only around $400 billion under February's balance -- four months away, if spending continues at the clip seen through January.
A lack of transparency as to how the reserves are managed is creating further unease. A portion of the fund is rumored to be locked away in relatively illiquid foreign investments, indicating that the amount of available capital could be a good deal less than the reported balance.
Central bank Deputy Gov. Yi Gang has said he believes the majority of China's dollar reserves to be held by the Chinese people. But a drop below the critical $2.8 trillion level would nevertheless set off market turbulence, likely reigniting yuan-selling.
The yuan is already steadily losing value against currencies other than the dollar -- the yen, in particular. A yuan fetched around 17.4 yen (around 15 cents for both currencies) on Thursday, over 10% less than it did at the 20.2 yen high reached in June. The slide has made Chinese exports to Japan more competitive but has cut the buying power of Chinese visitors to that country.
Beijing continues to insist that China does not and will not engage in competitive currency devaluations, leaving authorities with little choice but to intervene if such triggers as U.S. rate hikes cause the yuan to tumble once again. Investors worldwide are watching anxiously to see how long China can keep its reserve spending reined in.