from Follow the Money

Another month, another $30b for China’s central bank … but what happened in April?

June 28, 2006

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China’s reserves increased by around $20 billion in April and $30 billion in May – reaching $925 billion.   

China’s $20 billion April total was rather meager.  Russia added almost as much.  The Middle Kingdom usually doesn’t just top the reserve growth league table; it does so with style.  

May was more like what we have come to expect.

Seriously, China’s April reserve increase seems a bit on the low side. 

China's April trade surplus was around $10.5 billion.  And the euro rose from $1.214 to $1.262 or so during the month of April.   That should have increased the dollar value of China’s existing euro reserves in a big way.   Casson Rosenblatt and I estimated that 70% dollar/ 20% euro/ 10% yen reserve portfolio would have increased in value by $9.8b in April.    Or just assume China had around $200b in euros at the end of March (23% of its portfolio).  Those euros would be worth around $208b at the end of April.    

 The trade surplus and valuation alone should have generated a reserve increase of close to $20b.  Add in a typical month’s FDI inflows and ongoing hot money inflows, and I would have predicted a total closer to $30 billion. 

So why was China’s reserve growth “only” $20 billion” in April?

Three possibilities come to mind: 

  • Hot money inflows into China reversed in April, and became outflows.  If China attracted $5b in FDI inflows, it would have needed $5b in hot money outflows in April to limit its reserve growth to $20b.  This strikes me as unlikely.  Hot money flows into the rest of Asia picked up after the G-7 communique.  Generally speaking, intervention elsewhere in Asia picked up in April.   And hot money flows seem to have resumed in May, judging from the $30b reserve growth.  But it is certainly possible.   As US interest rates continue to rise, the gap between US rates and low Chinese rates keeps on growing.
  • China holds more dollars and fewer euros than people think, so it didn’t experience $8-10b in valuation gains in April.  A very dollar heavy portfolio (think Japan’s 85% or so in dollars) though is hard is a bit hard to square with China’s strong q4 04 reserve growth (there was a big euro/ $ move back then, and China’s reserves jumped).   A dollar heavy portfolio also makes it hard to explain China’s strong May reserve growth, which presumably reflected some valuation gains.  The same 70/20/10 portfolio could explain $4.2b of China’s $30b may reserve growth.
  • Chinese outbound FDI picked up in April.   Say payments on one of the recent foreign acquisitions of one of China’s state oil companies were made in April.   Such outflows would help to offset ongoing FDI inflows.   

I like explanation number three.  But I don’t have the supporting evidence.  And if someone has a better explanation, do tell!

The $30 billion reserve increase in May fits my expectations a bit better.    China’s $13 billion monthly trade surplus in May pushed the total up.   Valuation gains were around $4b.   That implies capital inflows of around $13 billion – probably a mix of FDI and hot money.  

There is little doubt that China’s reserves are now huge.   They clearly are on track to hit $1 trillion in the third quarter. 

In reality, they probably are already very close to a trillion, if one includes dollars the PBoC has shifted to the state banks.  Remember China transferred $60 billion in reserves t to the state commercial banks – though most people think that the central bank has agreed to protect the banks from any exchange rate looses.  China also seems to have used around $6 billion in swaps (maybe more) with the banks to lower its reported reserves.  But under the swap contract, the central bank is obligated to buy back the dollars at fixed rate.  

Add $66b to $925b and you get a total that is darn close to $1 trillion at the end of May. 

Then throw in another $20b for June …

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