Tuesday 14, February 2017 by William Mullally

China currency reserves drop again

David Kohl, Chief Currency Strategist and Head Economist Germany, Julius Baer

China’s foreign-exchange reserves fell in January below the symbolic threshold level of $3 trillion. Capital outflows continued unabated and may even have increased to $82.7 billion. Nevertheless, we think that the Chinese authorities still have enough ammunition to defend the yuan or at least be able to lean against the depreciation pressure. Currency interventions alone will not be successful, however. To boost investor’s confidence in the longterm, higher interest rates and further signs of stable economic growth would be needed. Given that higher inflation rates and global growth dynamics are kicking in, we expect the Chinese government to be able to deliver on both fronts eventually. In the meantime, we expect the continued tightening of capital controls to raise the barrier to outflows. Slightly higher money market interest rates and unexpected interventions or moments of yuan liquidity stress to punish speculators, who take one-way depreciation bets on the yuan, are also highly likely to occur.

For the time being, a constructive sentiment towards China, including positive economic data surprises and encouraging readings of our China risk index, indicates that the muddle-through strategy on the foreign-exchange front seems to work. Furthermore, the Chinese economy continues to show signs of stabilisation as domestic demand grows stronger. The positive growth backdrop creates a fundamental argument against a free fall of the currency.

 

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