CHINA BLEEDS FOREIGN EXCHANGE RESERVES / THE WALL STREET JOURNAL

China Bleeds Foreign Exchange Reserves

By Alex Frangos
.
Sept. 7, 2015 6:46 a.m. ET

A $100 billion here, a $100 billion there, and pretty soon you’re talking about real money.

China’s foreign exchange reserves fell by just under $94 billion during the market mayhem in August, to $3.56 trillion, the central bank reported Monday. On a percentage basis, it was the biggest one-month drop since May 2012, which was also during a bout of currency depreciation and hard-landing fears.

China’s actual selling of reserves was probably even higher because of measurement effects.

Though a state secret, economists estimate the composition of China’s reserves as roughly 55% dollars and 45% other currencies, such as the euro and yen. Because reserves are reported in dollars, and because the euro was on average 1.14% stronger against the dollar last month, China’s actual selling was likely around $112 billion.

That said, the declines don’t pose an immediate threat to China’s national balance sheet.

Assuming China keeps a fixed exchange rate, but is unable to impose capital controls, under International Monetary Fund guidelines on short-term debt and other liabilities, China should keep at least $2.7 trillion, figures Société Générale economist Wei Yao.

Were China to allow the currency to float, it wouldn’t need to spend reserves defending it. In such a case, the amount of reserves needed under the IMF criterion drops to $1.5 trillion.

A truly market-determined exchange rate would also quickly fall to an equilibrium level that then encourages investors to dive back into an economy when they sense value.

But so long as China maintains such a tight leash on the yuan, outflow pressures will express themselves through reserve depletion rather than a weaker currency. Despite the fanfare that went with China’s policy shift in August, it has only timidly tested letting market forces drive the currency.

China has guided the yuan stronger in recent weeks, partly as a signal to investors to stop sending cash out of the economy. If that doesn’t work, at $100 billion a month, the day when China decides to let the currency take the pain could come sooner rather than later.