China’s foreign exchange reserves fall in December, CNY likely to face downside risk in months ahead

China’s foreign exchange reserves fell in December by USD 41.1 billion to USD 3.015 trillion. The authorities have managed to keep the FX reserves at more than the psychological level of 3 trillion, but the situation continues to be difficult as the nation still faces solid capital outflow pressures.

Officials of China acknowledged that most of the fall in the foreign exchange reserves in the last two years was because of market intervention. Even so, Chinese yuan still depreciated 5 percent against the USD in 2015 and 7 percent in 2016. This indicates towards the fact that the Chinese yuan would be even weaker without market intervention and capital control measures and that the market interventions would not alter market projections of a weaker CNY. Additional flexible FX regime is still the only solution from a long-term point of view, stated Commerzbank in a research report.

Meanwhile, the Chinese yuan is expected to continue to be driven by USD and face certain downside risk on a three-month horizon, noted Nordea Bank. In the long term, the high valuation of the US dollar is expected to keep additional gains restricted. This might underpin some correction in the USD/CNY pair back to 6.90 later in 2017, added Nordea Bank.

“Our scenario analysis shows that if the trade-weighted CFETS index is to be kept stable at the current level of 94-95, then the USD/CNY will gradually converge towards 6.80 at the end of 2018”, said Nordea Bank.