China’s FX reserves fall unexpectedly below USD 3 trillion in January

China’s foreign exchange reserves dropped unexpectedly at the end of January. It fell below the psychological level of USD 3 trillion. The FX reserves fell by USD 12 billion to USD 2.998 trillion from December’s USD 3.01 trillion. Market projections were for a drop to around USD 3 trillion. This is the first time that China’s foreign exchange reserves have dropped below USD 3 trillion. Immediately after the release of the data, the offshore CNH weakened 0.1 percent.

It is evident that capital outflow pressures stay in spite of the present of supportive factors, noted Commerzbank in a research report. Firstly, EUR and JPY gained 2.7 percent and 3.7 percent against the USD respectively in January, which should raise China’s foreign exchange reserves to increase by USD 30 billion from a valuation perspective. Secondly, China’s central bank actually cut the outright intervention in both onshore and offshore markets in the last few months that might have aided in slowing down the decline in reserves.

Thirdly, there were fewer trading days in January because of the Chinese New Year holidays, and the corporates are usually less active in holiday seasons. The volume of trading also dropped significantly in January.

However, China holding FX reserves below USD 3 trillion at present signifies that China has to reconsider its intervention strategy, stated Commerzbank. Since mid-2014, China’s central bank has burnt down nearly USD 1 trillion foreign exchange reserves to conduct market intervention.

In order to meet the IMF’s adequacy recommendation of FX reserves, China should hold its foreign exchange reserves of USD 2.3 trillion. The nation is not expected to permit the reserves to drop to below USD 2.3 trillion without any intervention. Thus it is likely that capital controls might stay as strict as currently and perhaps even be tightened, noted Nordea Bank in a research report.

“As long as the downward pressure to the FX reserves persists, China will continue liquidiating Treasuries to rebalance portfolio”, added Nordea Bank.