The People’s Bank of China is getting restive about the strength of the Chinese yuan. That is something to keep an eye on: Any attempt to prevent it from rallying further would provide fresh fuel for a clash between Beijing and Washington over currency manipulation.
At around 6.38 to the U.S. dollar, the yuan is at its strongest level since 2018. The currency needs to rise by only a little over 5% to hit a historical high. It has rallied by almost 12% in the past year already.
The PBOC said Monday that it would raise foreign-exchange reserve requirements for banks after a former central-bank official suggested to state media over the weekend that the currency’s recent strength wasn’t sustainable or desirable.
Given the central bank’s clear discomfort with the rally, the fact that China’s foreign-exchange reserves have barely risen in the past year is eyebrow raising. In the 2000s and early 2010s, China’s large trade surpluses were mirrored by large reserve accumulation.
Since the beginning of 2020, Chinese reserves have risen by 2.9% in U.S. dollar terms, compared with increases of 10.6% and 13.2% in South Korea and Taiwan, two economies that have recorded similarly strong export growth and strengthening currencies during the pandemic.
On the face of it, that would suggest that the PBOC hasn’t intervened much to check the yuan’s appreciation.
But other data tell a more complicated story. China’s balance-of-payments figures for the final quarter of 2020 showed a modest rise in reserve assets but a surge in two residual categories. The first, named “other investment,” covers transactions that can’t be classed as direct investment, portfolio investment or reserves. The second, “net errors and omissions,” is the final bucket that makes sure the balance of payments actually balances out. The two categories combined ran to over $200 billion in the final quarter of the year, the highest level on record.
Some of the outflow may simply represent domestic borrowers taking advantage of the weak dollar and strong yuan to repay dollar debt. New Chinese liabilities marked “loan” under the “other investment” category fell from $13 billion in the first quarter of 2020 to minus $44 billion in the final quarter of the year, meaning large-scale repayment.
But that still leaves much of the remainder of these huge capital outflows as a question mark. Alex Etra, senior strategist at Exante Data and a former Federal Reserve economist has noted that the two segments of the balance of payments align well with the accumulation of banks’ net foreign assets. And the Chinese central bank has long relied on state banks to intervene in the currency market, avoiding doing the heavy lifting, and the outright attention that would bring.
That method of leaning against further yuan strength attracts fewer headlines than accumulating reserves. But if that is indeed what is happening, it is unlikely to have escaped the attention of the U.S. Treasury Department. Going forward it will be worth keeping a close eye not only on the currency market, but also on the details of China’s payments data to game out the potential for political trouble ahead.
Write to Mike Bird at Mike.Bird@wsj.com
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