Recent Chinese Reserve Declines: No Cause for Immediate Concern
by Dr. John Mullin, November 12, 2018

China’s FX Reserves declined by US$ 34 billion in October, bringing this year’s cumulative loss to US$ 87 billion. There are at least two reasons to take this development in stride:

1. The US$ 87 billion decline amounts to a modest 2.8% of initial December 2017 reserves (US$ 3,140 billion).
2. Based on our estimates, more than half of the decline was due to currency valuation effects and not to balance of payments outflows. The negative valuation effects reflect the fact that US$ strength decreases the US$ value of Chinese FX Reserves held in non-US$ currencies such as the yen and euro. Stripping out these valuation effects, we calculate that this year’s cumulative balance of payments deficit amounted to only USD $33 billion (or roughly 1% of December 2017 reserves).

In our view, investor concerns about China are premature. Granted, China has implemented the types of expansionary policies that have often proven disastrous for emerging markets. Chinese domestic credit grew rapidly in response to the global financial crisis as Chinese authorities implemented countercyclical policies. And the Chinese central bank has implemented further countercyclical policy moves this year by decreasing short-term interest rates by roughly 1.5%. These developments warrant further monitoring. However, we think that the Chinese authorities are still well in control of the situation.