International | Jan 18 2010
By Chris Shaw
China’s trade balance surplus may have turned sharply lower as the global economy has slowed down, but as Danske Bank points out this has had no impact on the country’s accumulation of foreign exchange reserves, which hit a record high in December of last year of US$2,399 billion.This was in increase in the final quarter of US$127 billion.
While this was down from the September quarter increase of US$141 billion, part of the difference can be explained by changes in exchange rates, as the weaker US dollar boosted the September quarter numbers but the reverse happened in Q4 as the US dollar strengthened in the final quarter of the year.
More than half of the increase in reserves is now being driven by “hot money”, which Danske Bank classes as the part of the value adjusted change in foreign exchange reserves that can’t be explained by the trade balance surplus and foreign direct investment.
This hot money impact is setting the scene for a major policy challenge in its view as these inflows will make it hard to manage a gradual appreciation of the Chinese currency, as capital flows have become more important and make it more difficult to maintain an independent monetary policy while also maintaining the current quasi peg against the US dollar.
There is also a liquidity impact from the amount of hot money flowing into the economy via massive purchases of foreign exchange, Danske Bank suggesting this may be one contributing factor to the decision of the People’s Bank of China to lift its reserve requirements for banks last week.
Given uncertainty with respect to policy options such as tightening capital controls, further moves such as starting to liberalise capital flows are likely. Danske Bank suggests the resumption of gradual appreciation of the Chinese currency in 2010 will not necessarily stem these hot money flows or effectively bring them under control.