China: Forex reserves hit a 16-month high
The Euro’s 3.4% appreciation against the US dollar last month added about US$20bn to the stockpile. To prevent irrational outbound investment, the China Insurance Regulatory Commission announced in January that shareholders of insurance firms are not allowed to interfere in the operation of insurance funds. Measures to reduce leverage will also be introduced.
Seasonal factors also played a role. Corporate dollar supply outweighed demand ahead of the Chinese Lunar New Year and discouraged investors from converting the Chinese yuan into foreign currencies.
Looking forward, we expect foreign reserves to be broadly stable in 2018. Inflows into the onshore bond market and confidence in the economy have lifted the yuan up 4% YTD against the US dollar.
Notably, the yuan has been stable amidst increased volatility from the global market sell-off this week. CNY and CNH changed hands at 6.2550 and 6.2625, respectively, at 1:30pm on 7 February – their strongest levels since the 2015 devaluation. The onshore-offshore spot spread remains unchanged around -100 pips (CNY<CNH). 12-month implied volatility for USD/CNH hovered at 6%, compared to 10.6% seen in early-2016. The interbank market was relatively calm; repo rates were largely unchanged from last week.
Even if the global market sell-off deepens, don’t expect a repeat of 2015/16, i.e. a plunge in the yuan and capital flight. First and foremost, there will be no surprise one-off yuan devaluation like in August 2015. There are also less worries about the economy especially after full-year growth accelerated last year for the first time since 2010. The Caixin China Composite Purchasing Managers’ Index (PMI) released on Monday rose to 53.7 in January, its highest since January 2011. The firmness in the flash PMIs of developed countries at the start of the year also pointed to continuous support for exports from a global synchronised recovery.
Some downward pressure in the yuan exchange rate, however, can be expected if global markets remain volatile. Apart from safe haven bids in the US dollar, it would also discourage interbank rates from rising in China. Even so, don’t expect a disruptive depreciation due to the strong enforcement of capital flow measures and the prominent presence of state-owned banks to smoothen volatility in the forex market.
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Strategist - China & Hong Kong
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