Economic Watch: China FX reserves wane on strong dollar, diversification

The fourth consecutive monthly decline in China's foreign exchange reserves is not as worrisome as it appears, as a stronger dollar accounts for much of the change, with Chinese companies and households embracing a longer list of investment channels overseas.

STRONGER USD

The world's largest currency hoard fell to 3.12 trillion dollars as of the end of October, down 45.7 billion dollars from a month earlier, marking the lowest level since March 2011, according to data from the People's Bank of China, the nation's central bank.

This represented the largest monthly decline since January, triggering market worries, but analysts said the strengthening of the dollar was the primary reason behind this, as forex reserves such as the euro translate into smaller figures when denominated in stronger dollars.

China's forex reserves are composed of assets in various currencies, although the exact structure of this basket is unknown. The depreciation of non-dollar assets is expected to account for about 29 billion dollars of the forex reserve decrease, said Xie Yaxuan, a senior economist with China Merchants Securities.

This means that the capital outflow last month led to less than 17 billion dollars of the decline in the world's largest forex reserve stockpile, easing the pace from 18.8-billion-dollar-drop registered in September, Xie added.

His analysis was supported by other economists. Han Huishi, a veteran foreign exchange analyst, predicted that valuation effects caused by a stronger dollar accounted for about 30 billion dollars of the 45.7-billion-dollar contraction in October.

The dollar index, which measures the dollar against six major currencies, including the euro and sterling, advanced by about 3 percent last month to 98.35 on Oct. 31 on the back of a string of positive economic data from the world's largest economy, which strengthened the rationale for an interest rate spike by the U.S. Federal Reserve.

The recent depreciation of major currencies against the dollar was a more "passive" market response to U.S. interest rate hike expectations in December, and does not point to weaknesses in China's economic fundamentals, said Chen Ying, a senior analyst at CITIC Securities.

Despite difficulties in transitioning to a more consumption- and innovation-driven economy, China's GDP grew 6.7 percent in the third quarter, holding steady with the first and second quarters and outpacing many major economies.

CAPITAL OUTFLOW MANAGEABLE

Some economists dismissed concerns that the sharp decrease in October presaged that capital outflow would eat into China's mountain of forex reserves at an uncontrollable speed.

Ren Zeping, chief economist at Founder Securities, cited the uptick last month in China's forex reserves denominated in the IMF's Special Drawing Rights (SDR) as evidence that capital outflow is manageable, despite some depreciation pressure facing the Chinese currency.

Coupled with the second-largest monthly decline this year in forex reserves denominated in dollars last month, China's forex reserves stood at 2.27 trillion SDR as of October, increasing by 2.98 billion SDR from a month earlier.

The room for the dollar index to climb further this year is limited, as the news of a potential U.S. interest rate hike has been almost fully digested by the market, Chen said.

Much of the capital outflows from China signal healthy developments, in the sense that Chinese households are diversifying international asset portfolios and Chinese corporations are investing overseas and developing global businesses, said Charles Collyns, managing director and chief economist at the Washington-based Institute of International Finance (IIF).

The view was echoed by Wen Bin, a researcher at China Minsheng Bank, who held that the decline of the Chinese central bank's forex reserves was accompanied by more assets held by Chinese families and companies overseas.

China's non-financial outbound direct investment (ODI) surged 53.7 percent from a year ago to 882.78 billion yuan (134.22 billion dollars) in the January-September period, official data showed.

In 2007, China increased the quota for individual forex purchases from 20,000 dollars per person a year to 50,000 dollars.

Capital outflows from China have diminished in the past several months, compared with the second half of last year and earlier this year, as China's policymakers continued to focus on supporting economic growth and avoiding exchange rate volatility, Collyns noted. Enditem

(Xinhua reporters You Zhixin and Wu Yu contributed to the stor