China Macro:Aug FX reserves number indicates capital outflows are manageable

China just released Aug FX reserves number, which declined by $94bn(Bloomberg consensus: $71bn). August FX reserves number has attractedmore attention than usual because the market worries about capitaloutflows/FX adequacy. In our view, today’s data suggests that such concernsare overdone. We expect the currency market to stabilize and are comfortablewith our 6.4 year-end forecast for USD/CNY.

Currently, there are two myths on RMB and FX reserves. The first one is toextrapolate the current pace of FX reserves depletion into the future. Thesecond is to assume that the PBoC will let RMB go due to the cost andsustainability of intervention.

In our view, both are problematic. For the first one, this Aug is not a normaltime. It is a month with unexpected devaluation, China hard landing fears andEM turmoils. However, the PBoC has sent out clear signals that it wants astable currency at least by the year-end. With stabilized expectation on RMBand more companies get their position hedged, the pace of FX reservesdecline should slow down as the result. Indeed, the onshore market turnoverhas already dropped by around 25% in early Sep compared with late Aug.

China still has $3.6tn FX reserves by Aug (it could use more if including othergovernment agencies such as Huijin, CIC, AIIB, etc). Given the $94bn drop ofFX reserves in Aug, the PBoC could carry out the current pace ofinterventions not for months, but for years. The market will give up fightingwith the PBoC well before China’s central bank runs out of FX reserves.

For the second one, while some might see lower FX reserves as a cost toChina, we would argue that China’s policy makers would be happy to seethat. After all, high FX reserves means the PBoC receives lower return fromits assets (mainly $) than the cost on its liability (mainly RMB). That’s whyPremier Li said in 2014 that “Foreign exchange reserves have become a bigburden for us.” To be sure, the PBoC doesn’t want to see FX reserves to falltoo rapidly, as it will tighten domestic liquidity. But a monthly pace of $50bn-$100bn is fine. The PBoC just needs to cut RRR every two months to injectliquidity to the banking system.

Lastly, it’s important to bear in mind that a drop of FX reserves doesn’tnecessarily mean that money flows out of China, the kind of capital flight thathas happened in many EM countries in history. As we discussed in What isChina’s actual capital outflow?, a large proportion of the money simply hasshifted from FX reserves owned by the PBoC to FX deposits owned by theprivate sector. Since the interest rate for RMB deposits is higher than FXdeposits, some of the money will be converted into RMB as the depreciationexpectation has stabilized.

Net net, while the drop of $94bn FX reserves in Aug might be viewednegatively by many and lead to further selloff in the CNH market, we view it asa positive signal, suggesting that FX reserves adequacy is not an issue andthe PBoC has the capability to maintain a stable RMB by the year-end.