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China’s State Administration of Foreign Exchange (SAFE) indicated that the level of foreign exchange reserves shrank by USD 12 billion in January, falling under the USD 3 trillion psychological floor to USD 2.998 trillion, marking a return to levels not seen since 2011. When the effect of the dollar’s fall against the major currencies, which raises the value of China’s non-USD foreign exchange reserves, is taken into account, the fall is closer to USD 40 billion, slightly more than was seen in December.
The changes in China’s foreign exchange reserves together with January’s trade balance numbers allow an estimation of the volume of capital outflows which appear to have accelerated over the month, despite the authorities’ tighter controls. Although the official reserves remain at ‘adequate’ levels (for example, they cover the level of short-term foreign debt threefold), the rapid rate of the shrinkage is noteworthy.
To halt the trend, one solution would be to allow the currency to float freely, running the risk of creating a wave of panic. An alternative solution would be to raise interest rates to attract capital inflows, although this would put already indebted companies under further pressure. Hence, the Chinese authorities will most likely continue with capital controls, although it remains to be seen how effective the strategy is.
The opinion expressed above is dated February 13th, 2017 and is liable to change.
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