BEIJING: Global investors are bracing for data next week that could show a big drop in China’s foreign exchange reserves as the central bank steps up its intervention to stabilise the yuan currency after its shock devaluation last month.

China has been so surprised by the global market reaction to its devaluation that it is likely to keep the yuan on a tight leash in the near-term to head off fears of a global currency war, policy insiders told Reuters.

But many traders believe there is political pressure to allow a deeper depreciation in coming months as the world’s second-largest economy slows.

China’s foreign exchange reserves, the world’s largest, have been falling from a record $3.99 trillion in June 2014 due to a wave of capital outflows fuelled by jitters about its economic slowdown and an expected move by the US Federal Reserve to raise interest rates.

Foreign exchange reserves fell by $42.5 billion in July to $3.65 trillion, the sharpest monthly drop since March.

The decline appeared to have quickened after China’s near 2 per cent devaluation of the yuan on Aug 11 stoked fresh concerns about its economy. The move sparked heavy selling of the yuan, and the central bank has intervened repeatedly since then via state banks to sell dollars to shore up the currency.

Analysts at Barclays Capital estimate the People’s Bank of China (PBOC) stepped up its foreign exchange intervention to $122bn in August from about $50bn in July.

“If the current pace of FX intervention continues, we estimate that the PBOC could lose up to around 14pc of its FX reserves (ex valuation adjustments) between June and December,” Barclays said in a research note.

“We estimate the PBOC would have to reduce the reserve requirement ratio by around 40 basis points a month just to offset the impact of its FX operations on domestic liquidity.”

Moreover, much of the money released into the economy by cutting banks’ reserve requirements may merely replace funds being moved offshore, rather than finding its way into new loans to companies which would support the real economy.

“We do not believe the present policy is sustainable given the associated costs in terms of FX reserves depletion and liquidity imbalances,” Barclays said.

“As such, we maintain our view that the yuan will need to depreciate further to stabilise capital outflows; we forecast a further 7pc fall by year-end.”

A Reuters poll on Friday showed strategists expect the yuan to weaken another 2pc in six months, though some were more pessimistic and predicted it would dive to 6.80 in 12 months from around 6.35 on Friday.

Nomura said on Thursday that intervention in August could be around $170bn, an unprecedented amount for just one month.—Reuters

Published in Dawn, September 5th, 2015

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