With China’s “Two Sessions” currently taking place, and Beijing hard-pressed to report positive economic data (including banning the sale of stocks by some mutual funds according to Bloomberg), it was perhaps not surprising that overnight China reported that its foreign-currency reserves “unexpectedly” rose in February for the first time since June 2016, halting a seven-month decline, rebounding over the psychological $3 trillion level controls on capital outflows and a rally in the yuan. China’s foreign reserve holdings increased by $6.9 billion to $3.005 trillion last month the PBOC reported, exceeding the consensus estimate for a $30 billion decline to $2.969 trillion. According to Goldman calculations, after adjusting for currency valuation effects, reserves rose by about $19 billion.
Among the factors cited for the rebound in the world’s biggest FX reserve holdings are stronger economic growth, stricter capital controls and a stabilizing yuan. China’s reserves have shrunk by $1 trillion from a peak of $4 trillion in 2014 as Beijing has struggled to slow yuan depreciation. Following the positive data, the offshore yuan extended gains to rise as much as 0.17%, although it has since given up all gains and was little changed at 6.8975. With pressure on reserves easing in recent months, the onshore yuan has advanced 0.7% this year amid a decline in the Bloomberg Dollar Spot Index.
“The rebound is a surprise as there should have been a negative valuation effective given that the dollar gained in February,” said Zhou Hao, an economist at Commerzbank AG in Singapore. “The increase shows the PBOC probably hasn’t been doing much spot market intervention last month, given market sentiment was stable and onshore yuan trade volume has been lower than usual.”
“Strict capital controls have taken effect, as it has reduced outflows and helped market sentiment on the yuan,” Nomura’s Zhao Yang told Bloomberg. “Reserves still face pressures, as the nation won’t want to keep tight capital controls in place for the medium term as they create difficulties for firms and thus weigh on the economy.”
In recent months Chinese authorities have boosted efforts to prevent outflows since late 2016, as the yuan headed for the biggest annual loss in more than two decades. Measures include ordering banks to stop processing cross-border yuan payments until they balance inflows and outflows, and even cracking down on bitcoin. Additionally, China’s residents face tougher reporting requirements when they want to convert yuan into foreign currency.
“The fact that they showed the world that the reserves are stabilizing at a fairly high number is an important signal,” said Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis SA in Hong Kong. “The realization that the leadership wants us to have is that China is out of the woods, it’s not losing reserves, and we’re back to normal.”
In a statement posted by China’s FX regulator, the State Administration of Foreign Exchange, it said that outflow pressures are expected to ease and reserves may gradually stabilize, however it added that global financial market uncertainties remain.
Meanwhile, in a note from Goldman, the bank warned that estimates of overall valuation effects can be noisy, pointing out that SAFE indicated that the market value of the reserve portfolio increased in Feb, which counteracted the negative currency valuation effect. That said, it is unclear exactly how large these effects were in Feb (and it has not always been obvious how the portfolio valuation effects are recorded). Therefore, as Goldman has traditionally cautioned, another dataset, the “PBOC’s FX position” (usually released in the middle of the month), will give us a much better sense of the PBOC’s FX sales net of valuation effects, as this dataset shows the PBOC’s FX assets recorded at book value. On several occasions in the past year this dataset has suggested a meaningfully different amount of FX sales by the PBOC than implied by the reserve data.
For reference, in January the PBOC’s FX position dataset showed a decline of US$30bn, even after a strong trade surplus of US$33bn (including merchandise and service trade). The trade surplus was likely not nearly as strong in Feb due to Chinese new year seasonality—in other words, the capital account dynamics would have needed to undergo a significant reversal for the PBOC to accumulate (rather than de-accumulate) FX assets in Feb.
In general, reserve data provide only partial information on the FX flow situation, and readers should await further SAFE and PBOC data to assess the underlying trend. In terms of the macro backdrop, the relatively subdued USD, which helped to stabilize USD/CNY even as the CNY continued to weaken moderately against the CFETS basket (by 0.4% in Feb, and cumulatively by 1% since end-‘16), has likely supported CNY sentiment. The various capital flow management measures introduced in the last few months have likely also helped slow outflows.
Looking farther ahead, recent policy signals and news suggest that the process of getting domestic bonds included in global bond indices has gathered pace. The amount of bond inflows following the SDR inclusion decision and more liberalized access to the domestic market by central bank-type investors has been fairly modest (about US$30bn over the past year) and may be less than hoped for. This has likely made the authorities keener to attract more bond inflows from private investors through the inclusion in the major global bond indices, which could potentially bring in significant foreign investment. This may not materialize any time soon and the precise timing is hard to predict, but continued news on this front bears close watching in the coming months.
via http://ift.tt/2me21td Tyler Durden