What is going on with China’s reserves?

Are they up? That is what one Chinese source suggested in late November. Logan Wright of Stone and McCarthy took a peak at the PBoC’s balance sheet and it indicated that reserves (measured in RMB) were up in October, in part because the central bank reduced the dollar reserves that the state banks were required to hold.

Or are they down, as a set of leaks over the weekend suggest?

As Michael Pettis notes, it is an important question -- and there isn’t yet any hard data points.

1) The rise in China’s trade in surplus in q4 (we have data from October and November) certainly suggests that there is an underlying basis for ongoing reserve growth. And the fact that the Fed’s custodial holdings have been constant even as other countries’ reserves have been falling suggests that someone has been adding to their reserves -- or that some central banks have been shifting money into the Fed for safekeeping because they no longer trust private custodians. For that matter some of the money that China shifted to the state banks might have come back to the PBoC -- and as a result, the PBoC would have additional money to buy US bonds.

2) Exchange rate moves -- notably the dollar’s rise against the euro -- would have cut into the dollar value of China’s reserves in October and November. October in particular. I estimate that the valuation losses on China’s foreign exchange reserves in October and November were in the $65-70 billion range. That could explain a portion of the fall -- and it is consistent with an ongoing rise 9or at least stability) in China’s US holdings. But one would expect that the bulk of the valuation losses to come in October, not November.* And if the dollar’s recent slide is sustained for another week, valuation gains on China’s euros and the like should add around $50 billion to China’s reported December reserves.

3) If -- as is widely believed -- SAFE put about 5% of its portfolio into equities in 2007 and early 2008 and if SAFE marks its equity portfolio to market, it should have additional valuation losses in October and November. On the other hand, this also should have an impact on the q3 data -- especially the data for September. I simply don’t yet know how SAFE is accounting for fluctuations in its equity portfolio. But so long as China put no more than 5% of its reserves into equities, it is hard to see how q4 losses could top $25 billion ...

4) The market -- the offshore market for betting on the future direction of the yuan -- now expects a depreciation of the Chinese yuan. The surprising rise in Hong Kong’s reserves in November suggests that many in Hong Kong are no longer betting on yuan appreciation, and consequently have moved money back into the Hong Kong dollar. The sharp slowdown in activity in China also provides another reason for hot money to move out of China ...

5) A strong dollar -- whether in 1998, after the Asian crisis, or in 2008, after the Lehman crisis -- historically has been associated with hot money outflows from China. Chinese investors tend to believe that the yuan will rise against the dollar when the dollar is weak, and to worry that the yuan might depreciate against the dollar when the dollar is strong. To the extent this is true, a lot more money would be expected to have left China in November than December.

Bottom line: I don’t think anyone outside SAFE has a good read on what is really happening. Today’s leaks probably refer to end November numbers. The end December numbers should be back above $1.9 trillion absent enormous capital outflows. Currency moves will push up the dollar value of China’s reserves in December, after pushing them down in October and November. Roughly $20 billion in valuation losses from currency moves isn’t enough to offset China’s likely q4 trade surplus ($75 billion in the first two months, likely to be close to $100 billion for the quarter). Even if $25 billion in equity losses are added to the $20 billion in estimated currency losses, China’s reserves should still be growing absent significant capital outflows ...

There is a bigger point as well: China doesn’t release its reserves data in a transparent way. The CIC hasn’t carried through on its stated desire to be as transparent as Norway’s sovereign fund. And the PBoC is less transparent than most other central banks. Even the Saudis -- hardly a beacon of transparency -- have formally released data on their October reserves. The main reason outsiders don’t know what is happening is that China’s leadership doesn’t want seem to want outsiders to know what is happening ...

* If China’s headline reserves fell by around $16b in October (as one source suggests), that doesn’t imply that any money actually left China. Currency valuation losses in October could easily have been over $60 billion -- which would imply underlying reserve growth was still positive. Very roughly, $60b - $15 = $45b in "valuation adjusted" reserve growth, or about $10b more than implied by China’s October trade surplus. On the other hand, the PBoC’s other foreign assets (the dollar reserve requirement imposed on the state banks) fell in October -- which might otherwise have been expected to have pushed China’s headline reserves up more. All in all, the limited available data suggests modest hot money outflows in October. I would guess those outflows picked up in November -- and don’t yet have a guess for December.