My Blog

June 25, 2008

I just got back from my one-week trip having taken a very early morning flight, so I am a little too tired to write much for today’s entry, but I couldn’t let pass a media report earlier this afternoon that claims that China’s foreign currency reserves at the end of May reached $1.797 trillion..  Although these media reports are unofficial, they have in every case that I can think of been subsequently confirmed by the PBoC, and these are very likely to be accurate numbers.

If so, this means that China’s foreign currency reserves grew by $40.3 billion in the month of May.  After the blowout $74.5 billion for the month of April there is the obvious temptation to think this is a relatively healthy number for China’s reserve growth, but it isn’t.  This is a huge number, materially above the $38.2 billion monthly average for 2007, a number that at the time was almost impossible to believe.  May’s $40.3 billion only seems small because monthly reserve growth year to date has averaged $53.7 billion, and it is worth reminding readers that, like the headline reserve growth numbers for the rest of this year, May’s number almost certainly significantly understates the true growth in reserves.

To recreate the chart I have been running every month, a reasonable and very plausible description of the composition of inflows to China’s PBoC this year looks like this:

To explain the chart, the trade surplus and FDI numbers for May were reported as $20.2 billion and $7.8 billion respectively.  Interest income is broadly the same as last month and I think currency gains in May were quite low (I will check with my friend Logan Wright, who tracks this better than I do).  There was another 50 bps hike in minimum reserve requirements for banks, and probably about $22 billion of that was redenominated into dollars, thereby pulling headline reserve growth down, although the monetary impact is nil.

Add and subtract the relevant numbers and we are left with about $27 billion of unexplained inflows into China for the month of May.  This is not necessarily all hot money, but it is a good proxy for hot money, and anyway it is a pretty safe bet that a significant part of FDI and the trade surplus really consists of disguised hot money. 

Over the year, the unexplained part of total adjusted inflows, including the redenomination of reserves and the transfer to the CIC, may amount to as much as a whopping $257 billion, which is only slightly less than the headline growth in reserves.

Surprisingly enough, or perhaps not so surprising given the amount of pain many banks are reported to be feeling, according to today’s Bloomberg a recent survey of Chinese banks by the PBoC suggests that Chinese banks believe monetary policy is too tight:

Chinese bankers say monetary policy is too tight and their expectations for interest rates to rise have eased, a central bank survey showed.  Policy is “tight” or “too tight,” according to about two-thirds of 2,900 heads of financial institutions surveyed by the People's Bank of China this quarter.

According to the survey the banks regard current levels of interest rates – well below zero in real terms – as appropriate.  These kinds of complaints are likely to make it difficult for the PBoC to raise rates, especially when it seems that consensus is again shifting to concerns that an economic slowdown is a much greater threat than monetary excess.

Comments (9) for "China’s reserves grew $40.3 ...

Mr Pettis Your last commnent on the banks is interesting, was watching a Chinese financial news programme, the episode broadcasted last week concentrated on hot flows, apparently, the banks have had no choice but to toe the official line, even though the "private loans market" interest rates have reached 20% or more, companies have been having poroblems getting loans, and the banks have had to watch from the sidelines. Wonder if the us$ denominated loans are the solution. Sorry if it sounds all patchy, but blogged about that last week! By Judy Yeo - 6/24/2008 7:22 PM

Michael -- is there any particular reason to think the entire CIC transfer came in March? my operating assumption was a little in Jan, a little in Fed and then the majority in March (b/c of the low reserve number). But that was just an assumption ... By bsetser - 6/24/2008 9:56 PM

Supposed to read 1.797 trillion not billion in first paragraph, I think... By Nick Consonery - 6/24/2008 10:14 PM

Is there any way to link China's burgeoning reserves to global commodities? Does the large reserve base enhance the country's ability to pay for its evergrowing appetite for oil, coal, etc. If so perhaps the strategy can continue for quite awhile because it simply has to. By Francis - 6/25/2008 9:30 AM

Brad, I am not sure when the transfer took place in Q1, but I stuck it all in March partly for simplicity and partly because there was a small bit of evidence that it might have happened then. The timing of the transfers matters if you want to get a better sense of the timing of inflows, but otherwise it doesn't matter too much. Francis, I think there are good reasons for China to want large reserves, mostly to do with the terrible demographic chnages it faces in the next few decades, but at this point the amounts are too large and further increase in reserves is not part of their strategy. They would like it to slow down but have no control ovr it except unless they dranatically address the currency regime, something they have not yet been willing to do. Judy, I think USD loans are partly being used to get around loan caps. i wrote about his a few weeks ago. Nick, thanks. I changed it. By Michael Pettis - 6/25/2008 1:37 PM

"I think USD loans are partly being used to get around loan caps. i wrote about his a few weeks ago." Nice carry trade, companies borrowing USD under loans denominated in USD, and then exchanging the proceeds for renmimbi at the spot rate on extension of the loan. By etc - 6/25/2008 5:28 PM

Etc, unfortunately it is not as easy a carry trade as all that. Domestic dollar loans have very high interest rates -- LIBOR plus 9% I was told two weeks ago -- and anyway my understanding is that most of these are swapped into RMB. By Michael Pettis - 6/25/2008 7:35 PM

Mr. Pettis, Related to: "Over the year, the unexplained part of total adjusted inflows, including the redenomination of reserves and the transfer to the CIC, may amount to as much as a whopping $257 billion, which is only slightly less than the headline growth in reserves." I have a quick question: to what extent do black pools have access on mainland capital and can the central government effectively this access? By TGS - 6/26/2008 4:39 AM

correction * and can the central government effectively control this access? By TGS - 6/26/2008 4:41 AM