By the end of March, China’s foreign exchange reserves stood at $3.17 trillion, down $35 billion in a single month, the biggest drop in a year, the third consecutive month of decline in China’s foreign reserves.
On Wednesday (April 7), the State Administration of Foreign Exchange of the Communist Party of China released data showing that foreign exchange reserves fell to $3,170.3 billion in March, below market expectations of $3,178 billion, and $3,204.9 billion in February.
Reuters reported that the EIKON terminal showed that the U.S. dollar index appreciated 2.59% in March, while the euro and the British pound depreciated 2.87% and 1.10% against the U.S. dollar, and the yen depreciated 3.72% against the U.S. dollar; while the 10-year U.S. bond yield rose 29 basis points (BP) in March, European and Japanese 10-year Treasury yields fell slightly. According to Reuters calculations, the exchange rate fluctuations in March brought about $26 billion of negative valuation effects.
The resulting estimate is that capital outflows led to a reduction in external reserves of about $9 billion in March; last month’s capital outflows led to a reduction in external reserves of about $6.7 billion.
Capital outflows are always an important issue for China, said Qu Tianshi, an economist at Bloomberg Economics Research, adding that “the (Communist) authorities may also be concerned about capital inflows, especially hot money, turning into capital outflows when market conditions change.”
Bloomberg reports that the size of the inflows puts China at risk of an asset bubble that could burst once the money starts pouring out.
Unlike Western countries, China’s foreign reserves must be converted into yuan on entry and then into dollars or other sovereign currencies on exit due to capital controls, which means that China’s foreign reserves bear the responsibility of cashing out, which will put pressure on China’s foreign reserves if there is a large outflow of foreign capital.
Currently, market expectations of strong U.S. economic growth are pushing up U.S. Treasury bond yield rates, narrowing the yield premium on Chinese Treasuries by about 1 percentage point from its record high in November. It has also boosted the dollar and weighed on the yuan, which depreciated about 1.3% in March. The stock market’s CSI 300 index has fallen more than 10% from its highs this year.
This change in the market is changing the direction of capital flows. As the interest rate differential between China and the U.S. narrowed further, foreign investors’ enthusiasm for buying Chinese bonds finally suffered a significant cooling.
The latest statistics from the China Foreign Exchange Trade Center (CFETS) show that in March, foreign institutional investors bought a net 51.4 billion yuan of bonds in the interbank bond market; this was a big drop of more than 60% from the previous month’s size, and even less than 20% in January this year.
On April 7, Reuters calculated that foreign institutional investors reduced their holdings of Chinese government bonds by 16.5 billion yuan in March, the first reduction in the size of government bonds held by overseas investors since February 2019, according to the latest data from the China Bond Depository, which had a custody balance of 2,044 billion yuan at the end of March.
Previous CDS data showed the balance of government bonds held in custody by overseas institutional investors stood at 2,060.5 billion yuan in February.
According to Bloomberg, more than $400 billion of foreign capital poured into China’s bond and stock markets last year, which will flow back to the U.S. as the U.S. economy recovers strongly.
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