China Forex Reserves Increase at Slowest Pace in 11 Years

By Bloomberg News
July 12 (Bloomberg) -- China’s foreign-exchange reserves, the world’s largest, rose at the slowest pace in 11 years in the second quarter as expectations for a yuan appreciation diminished and the European sovereign debt crisis saw capital move out of emerging markets.
The nation’s holdings rose by $7.2 billion to $2.454 trillion yuan at the end of June from the end of March, the People’s Bank of China said yesterday, the smallest increase since the second quarter of 2001. Reserves dropped 2 percent in May, according to data posted on the central bank’s website, the first monthly decline since February 2009.
China’s announcement that it was scrapping its two-year peg to the U.S. dollar was made just 12 days before the end of the quarter. The change in policy could revive bets on the yuan’s appreciation and create added problems for the central bank in its attempts to control liquidity in the financial system and stem inflation.
“The temporary drop in reserves in May was related to the very low expectations for gains in the yuan’s exchange rate,” which reduced the country’s attractiveness to capital inflows, said Xing Ziqiang, a Beijing-based economist with China International Capital Corp. “We’re likely to see average monthly trade surpluses of a relatively large $20 billion and expectations for yuan gains are also stronger,” indicating reserves will increase over the next few months, he said.
The yuan, which has risen 0.8 percent in the three weeks since the central bank’s announcement, may gain 4 percent this year and 6 percent in 2011, according to Wang Qing, a Hong Kong-based economist at Morgan Stanley. DBS Group Holdings Ltd. predicts the currency will advance a further 1.2 percent this year as the central bank acts to temper inflation.
Lending Slows
Money supply grew in June at the weakest pace since December 2008 and lending growth slowed for the third month, reflecting government curbs on credit to some industries, the central bank said yesterday.
M2, the broadest measure of money supply, slowed for seventh straight month, growing 18.5 percent from a year earlier, compared with 21 percent in May. The median forecast in a Bloomberg News survey was for a gain of 18.8 percent. New yuan-denominated loans were 603.4 billion yuan ($89 billion) compared with 639.4 billion in May. The median forecast in a Bloomberg survey was for 600 billion yuan.
The People’s Bank of China said July 8 that money and loan growth in the first half was “reasonable” and liquidity in the banking system “basically appropriate,” suggesting more significant policy measures, including raisinginterest rates or banks’ reserve requirements, are unlikely in the short term.
Investor Pessimism
“The central bank is using credit quotas to slow lending growth and that’s reflected in the money supply,” said Wang Tao, an economist at UBS AG in Beijing. “As long as lending is slowing according to plan, worries aboutinflation getting out of control are much less,” making policy tightening less likely, she said.
The slower pace of foreign-exchange reserve accumulation in the second quarter reflects pessimism among international investors about the outlook for China’s equity and property markets, according to Tom Orlik, Beijing-based analyst for Stone & McCarthy Research Associates.
“We haven’t seen this scale of outflows since the flight to quality at end of 2008 and early 2009 at the peak of concerns about the global economic crisis,” Orlik said. He estimates that even accounting for the higher trade surplus and greater overseas investment by Chinese companies in the second quarter, capital outflows may have amounted to $51 billion in May and $21 billion in June.
Stocks Fall
China’s benchmark stock index has dropped 25 percent this year, and government policies to crack down on real-estate speculation led to a slump of as much as 70 percent in housing transactions in some cities. Prices could fall by as much as 20 percent in a “healthy” correction, Michael Klibaner, head of China research at Jones Lang LaSalle Inc. said on July 7.
China is estimated by some economists to have invested as much as 70 percent of its reserves in U.S. dollar-denominated assets, and is the biggest overseas holder of U.S. Treasuries, with $900 billion at the end of April.
“Clearly, if there is slower growth in foreign-exchange reserves in the next few months through a lower trade surplus and reduced capital inflows, that may give China a smaller budget to buy U.S. Treasuries,” Orlik said. “But SAFE made quite extensive comments last week about the benefits of investing in U.S. government debt,” he said, referring to the State Administration of Foreign Exchange, China’s foreign- exchange regulator.
--Li YanpingZhang Dingmin. Editors: Nerys Avery, John McCluskey.