THREE hundred and twenty billion dollars. That is the amount by which China’s gargantuan foreign exchange reserves declined by in 2016, according to the latest data that has been made available by the People’s Bank of China. Chinese reserves, which peaked at $4 trillion in mid-2014, have fallen to $3.011tr, their lowest level since March 2011. The steep decline in reserves and a weakening yuan could create significant global economic headwinds.
Markets function as a herd. Euphoria can quickly give way to panic, and people’s perceptions can lead them to take actions that create facts in line with their perceptions. The present perception is that the yuan is overvalued and that China’s central bank will continue to intervene in the market to manage the currency’s decline.
The decline in the yuan began in August 2015 when the Chinese authorities made a surprise move, allowing the currency to depreciate by almost two per cent against the US dollar. This decision was made in a bid to deflate the currency after a steady appreciation in its value. The Chinese central bank has since taken a whole host of measures to manage the fall in the value of the yuan. These include directing state-owned banks to restrict lending in yuan to other banks, imposing extra requirements on conversion of yuan to the dollar, and increasing the currency’s daily trading range in the domestic market.
Akin to slowly opening a dam during a flood, the interventions are meant to ensure that the decline does not turn into a currency rout. As the yuan comes closer to the psychologically sensitive level of seven yuan to the dollar — it is currently priced at around 6.9 to the dollar – market participants are smelling blood and have increased their bets on further depreciation of the currency. A self-reinforcing cycle where the central bank intervenes and draws on its reserves to manage the decline, only for its actions to be perceived as being more evidence that the currency will further depreciate, is now beginning to take shape.The emerging turbulence in the yuan poses several challenges for Pakistan.
The result has been a continuous outflow of capital from China — net outflows reached $69.2 billion in November and have averaged close to $50bn a month since June 2016. The country has also burnt through $1tr in reserves in less than 17 months and the yuan has fallen by 6.5pc in the last year.
The pressure on the currency looks far from abating anytime soon. Rising interest rates and expectations........