Is the tide turning on China's reserves?

The rapid erosion of China’s currency buffer was a major worry for global investors at the start of the year. Between November and January, the country’s foreign exchange reserves fell by nearly USD 300 billion, not far short of Brazil’s entire stockpile. That pace of decline raised concerns that China was losing control and that capital flight would eventually push the yuan sharply lower. 

This threat continued to recede this month. China’s reserves climbed for the first time since October. And at USD 3.21 trillion, the stockpile is comfortably above the USD 2.6 trillion level the International Monetary Fund considers safe. 

Several reasons to feel encouraged by the stabilization:

1. The turnaround is a sign that the market has greater confidence in the willingness and ability of the People’s Bank of China (PBoC) to maintain currency stability. The central bank unsettled global markets in August 2015 by moving to a more flexible currency regime, a move that was seen by some as heralding a sustained devaluation. A tightening of capital controls by the PBoC over recent months has reassured markets that it wants to avoid unsettling currency moves. 
2. Corporate flows from China should also prove supportive. Much of the outflow from China after August was due to an effort by companies to buy back dollar-based debt and convert it into the home currency. Much of this process has now been completed, limiting a potential future drag on reserves. 
3. Finally, there are indications that the cyclical momentum is improving in China. The purchasing mangers’ index readings strengthened in March, and domestic steel prices are up over 40% since the lows at the end of last year.

Investors will need to keep a close eye on China’s reserves. But at least for now, there appear to be fewer causes for concern.

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