On March 26, the China Administration of Foreign Exchange (CAFE) announced China’s full-caliber foreign debt data for the end of 2020. From the published data, China’s external debt data continued to grow rapidly at the end of 2020. However, the foreign reserves data were relatively stable, and the growth rate of both varied, affecting the foreign reserves minus foreign debt balance to continue to reach a record low. in the first quarter of 2020, the foreign reserves minus foreign debt balance fell below the trillion dollar mark. By the fourth quarter of 2020, the balance of foreign reserves minus foreign debt fell to US$815.7 billion, a year-on-year decline of nearly a quarter from the previous year.
A source of foreign debt growth
Since the Epidemic, countries have scrambled to increase water releases, and overseas liquidity was unusually abundant in 2020. And China’s monetary policy began to normalize in late May 2020, which affected the widening of interest rate differentials between China and overseas, with overseas liquidity scrambling to pour into China.
The massive influx of overseas liquidity turns into China’s foreign debt, which grows rapidly in the third and fourth quarters of 2020. in the third quarter of 2020, $162 billion of new foreign debt is added in a single quarter, compared to $34 billion in the same period of 2019; in the fourth quarter of 2020, $106.4 billion of new foreign debt is added in a single quarter, compared to $7.8 billion in the same period of 2019, a huge increase! However, a little problem can be found therein: after November 2020, China’s credit debt market turmoil has affected monetary policy to relax, and the internal and external interest rate spreads have narrowed.
Logically, the narrowing of the spread will affect the influx of external liquidity.
Looking at the data released in 2020, in the fourth quarter of 2020, new external debt decreased by $55.6 billion (34.3%) from the third quarter, and the impact of narrowing spreads on external debt growth is still more obvious.
Interest rate spreads, the source of external debt growth.
Second balance
Liquidity can be divided into overseas influx (external) and domestic release (internal).
Central bank monetary policy wants to achieve the best effect of stimulating the economy, neither only internal liquidity nor external liquidity can be taken into account, but the best balance between domestic liquidity and overseas liquidity needs to be achieved.
After May 2020, China’s domestic liquidity tightened, but overseas liquidity poured into RMB assets in a steady stream. Boosted by overseas liquidity, Chinese asset prices rose sharply, with the Shanghai Stock Exchange surging over 20% from May to July 2020, with an unusually impressive balance of internal and external liquidity.
On the contrary, in 2018, China’s internal liquidity eased, with SHIBOR (3M) continuously going down, but the SSE decline continued throughout the year. The reason for this is that in 2018, when the US dollar raised interest rates and external liquidity had an incentive to flow back, the easing of internal liquidity instead fueled the return of external liquidity, thus exerting pressure on RMB assets.
When the influx of overseas liquidity, the balance of internal and external liquidity is easier to grasp, that even if the grasp is not good will only be accelerated accumulation of foreign reserves, accelerating the fueling of assets up. All is well. But when the dollar flows back, the balance of internal and external liquidity is more difficult to grasp. Foreign reserves and asset prices are both at risk of falling.
Protecting foreign reserves or asset prices? This will become a very difficult choice.
Three dollar reflows start
Starting in 2021, ten-year U.S. bond yields will accelerate higher, overseas dollar liquidity will turn a corner, dollar repatriation will accelerate, and a shortage of dollar global liquidity will start to appear.
According to the Federal Reserve’s Treasury bond custody data, foreign central banks’ holdings of U.S. Treasuries decreased by $109 billion in March, due to a shortage of global dollar liquidity in March, and many overseas central banks had to sell U.S. bonds in exchange for cash. And emerging countries to manage overseas liquidity means (if you do not consider administrative instruments), is nothing more than the exchange rate and interest rates.
Overseas liquidity is here to make money, not to do charity, if there is no money to make, overseas liquidity will run. Either the exchange rate differential is gainful or the interest rate differential is gainful, as long as overseas liquidity is allowed to earn money, they will not run away.
In order to retain overseas liquidity, emerging countries began to raise interest rates frequently.
Four risks are manageable?
For China.
1) China’s liquidity has been steadily easing recently, and Chinese 10-year Treasury yields are moving downward, while U.S. 10-year Treasury yields have been moving upward continuously, which has led to a rapid narrowing of the U.S.-China interest rate spread, which has now fallen from 252 basis points in July 2020 to the current 154 basis points, down nearly 100 basis points.
2) The US dollar index is also moving upward due to the upward movement of US bond yields. Returning to the U.S. dollar can gain both interest rate differential gains and exchange rate differential gains. And the RMB has a certain depreciation trend recently.
The double divergence between spread and exchange rate trends may lead to a reversal of the overseas liquidity pouring into China after May 2020. Once overseas liquidity reverses significantly and liquidity withdraws quickly, China’s foreign exchange reserves and asset prices will take a big hit.
In 2008, during the U.S. subprime crisis, external liquidity quickly withdrew and China’s 10-year Treasury bond yields soared to over 4.5%, hitting both the Chinese stock market and the economy, and decimating property prices in Shenzhen, while the rapid decline in foreign reserves minus foreign debt balances (representing a decline in the coverage of foreign reserves when external liquidity withdraws) may magnify the risk of a shock. ), which may magnify the risk of a shock.
In 2021, China seems to have started paying more attention to this risk. China’s State Administration of Foreign Exchange (SAFE) held a national TV conference on foreign exchange management in 2021 in early January, deploying key foreign exchange management tasks for 2021, the first of which is to prevent the risk of abnormal cross-border capital flows, strengthen the monitoring and assessment of the foreign exchange situation, pay close attention to the impact of external shocks such as epidemics, guide financial institutions and enterprises to adhere to the principle of risk neutrality, combat foreign exchange speculation, strengthen market expectations management and Macro-prudential management to avoid disorderly fluctuations in the foreign exchange market.
From this, it is clear that the leaders are well aware of the consequences of external liquidity shocks and are trying their best to avoid such consequences ……
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