Slow Burn

China’s foreign exchange reserves rose by $10.3 billion in headline terms in March, but currency valuation adjustments actually suggest a decline of $25 to 30 billion during the month, despite US dollar weakness following dovish comments from the Federal Reserve. Sorting out what has driven China’s capital outflows and the resulting pressure on the currency has been a critical question for markets following exchange rate volatility in 2015, but signals are mixed. China’s capital outflows have been driven primarily by repayment of external dollar-denominated debts, indicated via the “other investment” balance of the financial account. But official fourth quarter balance of payments data show a surprising slowdown in external deleveraging at the end of 2015, suggesting that pressure on the currency to weaken will persist.

Posted August 1, 2017
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