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China’s foreign exchange reserves dropped to its lowest level since 2012, reflecting that the People’s Bank of China (PBoC) should have defended USD/CNY at 6.70 last month. Looking ahead, it is expected that the PBoC will continue the market intervention, in both spot and forward markets. That said, downside risks in USD-CNH forward points persist in the near term.
China’s foreign reserves dropped by USD15.9 billion in August, to USD3.19 trillio, the lowest since 2012. In SDR terms, China’s FX reserves declined 17.3 billion SDR. As the valuation effects were quite small in the past month, the drop of FX reserves reflects that the PBoC should have taken actions to defend the USD-CNY at 6.70 hurdle.
Further, as the CNY will be officially included into SDR basket from October, it is believed that China’s central bank will continue to cap the USD-CNY at 6.70 in the foreseeable future, in order to avoid any unintended market volatility. Of course, this is not a sustainable strategy, reported Commerzbank.
While China’s FX reserves will likely illustrate a modest downward trend for the time being, downside risk of USD-CNH forward points in the coming months is anticipated. This is simply because China’s central bank will likely roll over its massive short USD dollar positions in the FX forward markets.
Currently, official number suggests that China’s central bank holds around USD29 billion equivalent short USD positions in the FX forward market, but it is quite difficult to quantify the size of the short USD-CNH forward positions conducted by the PBoC, the report added.
"We believe that China’s central bank intervened massively into the FX forward market in August- October 2015 and January-March 2016 to ease the depreciation pressure on CNY, and most of the positions are in one-year tenor, which is widely seen as a market benchmark," Commerzbank commented in the report.
Meanwhile, China’s central bank will roll over these positions in the forward market, which could send the USD-CNH FX forward points to lower levels.
