Thursday, the People’s Bank of China, the central bank, released data showing that China’s foreign exchange reserves increased $10.26 billion in March.
A Bloomberg survey had pointed to a $6.3 billion drop. A Reuters poll was even more downbeat. It estimated a decline of $20.0 billion.
China, for more than a half year, has reported reserves higher than expert forecasts. In fact, the report for the last month the PBOC claimed an increase in reserves—October of last year—was particularly surprising. In view of the reported capital outflow that month, it is not clear how Beijing managed to accumulate reserves during the period.
The March increase in reserves, the Wall Street Journal noted, is “a sign Beijing may have partially succeeded in stemming heavy capital outflows.” Yes, but there are also indications that Beijing is now including assets denominated in renminbi in its foreign exchange reserves.
As an initial matter, the State Administration of Foreign Exchange, the central bank unit managing the foreign reserves, has apparently been including CNH, renminbi outside China’s currency borders, in the reserves as theFinancial Times has reported.
Moreover, the South China Morning Post posted an article on Friday suggesting Beijing was including other renminbi-denominated assets. That paper reported that Wutongshu Investment Platform Co., wholly owned by SAFE, bought state bank shares, triggering a rally in China’s domestic stock markets. There is evidence of increased “National Team” buying last month, and Wutongshu’s purchases were presumably part of this effort to lift sagging indexes.
In any event, Wutongshu, formed in November 2014, is now a major holder in several commercial banks including Industrial and Commercial Bank of China, Bank of China, Bank of Communications, and Shanghai Pudong Development Bank.
There are various theories how Wutongshu acquired the shares in violation of a central bank rule prohibiting SAFE from making local-currency investments in China. First, Chen Li of Credit Suisse believes the holding company may have simply received the shares. He notes that China Securities Finance Corporation borrowed 1.2 trillion yuan from the PBOC to buy stock as a part of the central government’s market-support efforts. CSFC, however, couldn’t repay, so it may have surrendered the shares, which had fallen 15% to 25%, to the central bank in satisfaction of its obligation. Li thinks the PBOC transferred the shares to SAFE, which contributed them to Wutongshu.
If Li’s theory is correct, there was no diminution in the country’s forex reserves. In this case, Wutongshu merely received a contribution to capital.
More likely is the “guess” from Chen Bingcai of the Chinese Academy of Governance. Chen notes that SAFE could get around the no-domestic-investment ban by “entrusting” dollars to commercial banks to obtain local currency. Wutongshu’s purchase of local bank shares fits in with its existing portfolio of stakes in Beijing’s “policy banks,” lenders that act at the direction of the central government for development purposes.
SAFE was trying to “kill three birds with one stone,” said insider Li Jie of the Foreign Exchange Research Centre of the Central University of Finance and Economics to the South China Morning Post, referring to Wutongshu-style investments. The custodian of reserves supported the renminbi by selling forex, financed CSFC, and found a new investment for the forex reserves.
If Chen of the Chinese Academy of Governance and Li are correct, as they almost certainly are, SAFE is increasingly counting renminbi-denominated assets as foreign. This would be in line with the comments of Standard Chartered Bank’s Ding Shuang, who told the Post that SAFE is increasingly looking to unconventional uses for the reserves.
In March, Wutongshu’s “unconventional” holding of bank shares would have been a good investment as the Chinese market rose on sustained government support. Yet analysts should not cheer. A good investment one month can turn into a poor one the next, and, in any event, A-shares of Chinese banks should not be counted as foreign currency because they are not foreign and they are not currency.
Unfortunately, the problem may be wider than the bank stock. Wutsongshu holds interests in two other ventures, Beijing Fengshan Investments and Beijing Kunteng Investments, and these two in turn hold shares listed in China.
Of course, the PBOC may have done the right thing and not included the just-purchased renminbi-denominated assets in the forex reserves. Yet, given the fact that the reserves as reported by the central bank have been consistently in excess of outsider estimates, it is unlikely the bank made the required subtractions when forex was converted into renminbi. So there is a strong possibility that Wutsongshu’s local-currency holdings are still included in the reserves, as some suspect.
Beijing reported that its foreign exchange reserves amounted to $3.21 trillion at the end of last month. For years, there have been suspicions that not all the assets met the IMF’s definition of what may be included in reserves. And for years, no one cared because China’s reserves were obviously sufficient to meet its needs.
Yet with unprecedented capital outflow and hedge fund attacks on the renminbi, people now care. Up to now, those concerns have focused on the liquidity of assets.
Kyle Bass of Dallas-based Hayman Capital thinks as much as $1 trillion of China’s reserves are committed to long-term investments and are therefore not available to defend the renminbi.Bass has an incentive to exaggerate because he is shorting the currency, but there are some estimates even higher than his. Evan Lorenz of the widely followed Grant’s Interest Rate Observer, for example, speaks of a $1.2 trillion figure.
In this regard, Wutongshu’s first investment was $6.5 billion into Beijing’s Silk Road Fund, which almost certainly is not liquid.
Now, however, the concerns go beyond liquidity. Only a tight circle in Beijing knows whether SAFE has in fact been including renminbi in China’s foreign reserves, but revelations about Wutsongshu are unsettling, to say the least.