Ever since the Chinese economy started slowing and the country surprised markets with a currency devaluation in August, analysts have been scramblingto lower their estimates for pretty much anything concerning China.
Only one estimate is going up and that’s the one for capital outflows and the subsequent drain on foreign exchange reserves.
Since June this year, some estimates put the total number of outflows as high as$300 billion. In order to service the outflows and stabilize the exchange rate, China had to sell about $400 billion in foreign exchange reserves since August 2014. This number could reach $1.2 Trillion in a “downside scenario” according to Barclays.
“In such a downside scenario there could be pressure on the central bank to provide about 10-12 percent of GDP [up to $1.2 trillion per year] in reserves to the market to offset outflows as well as hedging demand,” the bank writes in a note.
The analysts particularly highlight the fact China will have to pay back a large chunk of $1.4 trillion of external debt within one year. Repaying external debt means taking money out of the country and moving it offshore to settle the repayment, a net-outflow.
According to the analysts, this is the unwind of the infamous carry trade, where speculators borrowed U.S. dollars to fund purchases of assets denominated in Chinese yuan.
Previously, investors and speculators who managed to get money into China got a sweet deal. Borrow at very low rates in U.S. dollars, invest the money for a guaranteed 10 percent in China, and don’t worry about defaults (forbidden by policy) and currency risk (pegged to the dollar).
The very fact that the first defaults have happened in China in the beginning of 2014 and the currency is no longer risk-free (August devaluation!) scared many investors out of the carry trade and led to the unwind.
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“Given the growing uncertainties surrounding China’s growth outlook and currency path, there has already been a slowing in the pace of demand for the yuan carry trade. Any future liquidation may increase the demand for dollars as capital outflows intensify,offshore yuan volatility increases and the currency weakens,” the analysts write.
The recent China Beige Book report of on-the-ground surveys supports this narrative. It says both yields on bank loans and domestic bonds have fallen sharply, indicating domestic monetary easing and a weaker currency.
For the United States, it could meansharply higher interest rates if China unloads $1.2 trillion of its remaining reserve stash of $3.5 trillion, a third of which consists of Treasury bonds.
Of course, China could also just let its currency drop 20 percent and keep the reserves, but it seems it is not quite ready for this kind of free market action.
http://www.theepochtimes.com/n3/1756239-china-may-have-to-sell-1-2-trillion-in-reserves-every-year/
