Some thoughts on China’s foreign exchange reserves

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China’s foreign exchange reserves stood at $ 3.1426 billion at the end of September 2020, down $ 22 billion or 0.7% from the end of August, according to State Administration data foreign exchange (SAFE). This change ended the five consecutive months of ramp-up. A stronger dollar and declining stock markets in Europe and the United States were the main reasons for the decline in foreign exchange reserves. However, the evolution of China’s foreign exchange reserves has always been at the center of the market and has sparked much discussion and Analysis. It was also considered an important indicator of China’s economic and monetary stability. In this regard, ANBOUND researchers will present here some perspectives on foreign exchange reserves.

In fact, foreign exchange reserves are not a notion of net assets, but rather a part of the balance of payments as external assets and internal liabilities. Since the balance of payments is mainly settled in United States dollars, from the point of view of international investment and trade, it can be understood as a concept of a similar position in which the main objective is to maintain the harmonious regulation of trade and investment between countries. Therefore, the amount of foreign exchange reserves of emerging countries is a major benchmark indicator of currency stability and economic stability, which is conducive to participation in the international market.

In terms of balance of payments, the largest part of China’s source of international income is its trade surplus in goods and services over the years. According to SAFE, from 1982 to 2019, China’s cumulative net inflows into its current account amounted to $ 3.5 trillion. It is the basis of China’s huge foreign exchange reserves. The other is a continued net inflow of foreign direct investment (FDI), in which the stock of FDI amounts to around USD 2 trillion. A considerable part of the inflow of foreign funds comes from external borrowing. At the end of 2019, China’s total external debt stood at $ 2.0573 billion. At the same time, foreign investment in the Chinese securities market has also increased in recent years. Foreign investors held $ 737.5 billion in domestic bonds and stocks at the end of June 2020, up 2.2 times from the end of 2015, according to central bank data. These are essentially the main component of China’s foreign exchange earnings.

In terms of outflows, China’s foreign direct investment (ODI) consumed part of the currencies, which became a major factor in the decline in foreign exchange reserves around 2015 as China’s capital outflows have increased considerably. Statistics show that in 2019, China’s ODI stock reached USD 2.20 trillion, making it the third largest ODI country in the world after the United States and the Netherlands. In addition, China has nearly $ 1.2 trillion in foreign loans and trade credits, nearly $ 600 billion in foreign portfolio investment, and about $ 800 billion in foreign currency and currency deposits. On top of that, nearly USD 3.2 trillion in official reserve assets constitute the bulk of China’s external assets (internal liabilities).

Of course, much of the makeup of official reserve assets is China’s official foreign exchange reserves, and there is no detailed data on their use. The size of China’s real foreign exchange reserves has been in the dark since it became a downward trend in 2015. On the other hand, China’s sharp increase in FDI around 2015, coupled with a reduction from its foreign trade surplus and capital outflows the depreciation of the RMB has significantly reduced the scale of its foreign exchange reserves by nearly one trillion US dollars, which is now held at around 3.2 trillion US dollars. Generally speaking, foreign exchange reserves refer to assets denominated in foreign currencies, including cash, foreign bank deposits, foreign securities, etc. buy titles such as obligations. About a third is spent on securities denominated in other currencies such as the euro and yen, with the remainder supposedly being in cash.

In fact, the main concern regarding China’s foreign exchange reserves is centered on the stability of the RMB, which is of great importance for the development and stability of the Chinese economy in the context of the evolution of the national and international economic environment. Of course, there has always been disagreement over how much foreign exchange reserves to keep and how to use them, with some arguing that it might be appropriate to keep them at around 10% of GDP. For example, Japan’s foreign exchange reserves are only USD 1,053 billion, but it holds over USD 5 trillion in foreign assets, ensuring the stability of the yen and the Japanese economy. Foreign exchange reserves should be moderately diversified in order to avoid the risk and loss of assets caused by the fluctuation of the US dollar exchange rate. However, for a large country like China, it is still necessary to maintain the stability of foreign exchange reserves dominated by the US dollar while the US dollar remains the main international currency.

On the one hand, China needs to guarantee its US $ 1 trillion foreign debt (including short-term and long-term external debt, excluding offshore RMB foreign debt) and the payment needs of foreign investment of about USD 2 trillion, albeit in the short term. – term capital flows require sufficient foreign currency to maintain China’s growing openness to the outside world. On the other hand, in terms of trade, Chinese imports of food products, oil, and chips alone are worth around $ 588.8 billion a year. In a changing international trade environment, there is always great pressure on China’s export industry to maintain its trade balance. If the current trend to move basic productive capacity out continues and a trade deficit emerges, the current level of foreign exchange reserves may not be able to withstand such “depletion”.

Of course, in the context of the drastic changes in the economy and trade brought about by the COVID-19 pandemic, avoiding the loss of foreign exchange reserves is also a more realistic question. In fact, the root of this problem lies in improving the ability of companies and the private sector to invest abroad, so as to build high-quality foreign assets. In addition, the issue of foreign exchange reserves is closely linked to the internationalization of the RMB. In the future, expanding foreign investment and trade in RMB and avoiding the use of the US dollar can certainly solve the problem of foreign exchange reserves. Since the reform and opening up of China, the continuous increase in foreign exchange reserves is a result of the continued expansion of the “external circulation” of the country’s economy, and the scale and structure of China’s reserves. exchange rate must also be adjusted appropriately according to the future “dual circulation” model of the Chinese economy.

Conclusion of the final analysis

The size of foreign exchange reserves is closely related to the creditworthiness of the US dollar and the RMB. Maintaining large foreign exchange reserves is still necessary for the Chinese economy and currency stability. In the long term, strengthening the capacity of ODI and increasing assets abroad are the basic measures to maintain a stable currency.

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