China's foreign exchange reserves have fallen below $US3 trillion ($3.9 trillion) for the first time since February 2011, as the central bank intervened to support the yuan and capital flowed out of the country chasing higher returns.
The People's Bank of China said reserves dropped for a seventh straight month by $US12.3 billion in January to $US2.9982 trillion. While the fall was small compared to the $US100 billion decline at the beginning of last year, and the $US41 billion decline in December, it was slightly bigger than expected.
Most analysts had predicted the government's recent tightening of capital controls would keep the reserves just above the psychologically important level of $US3 trillion.
China's war chest has been much depleted since it reached a peak of $US4 trillion in June 2014. Last year, the PBOC was forced to intervene heavily to support the yuan, in the face of a strengthening US dollar. Even with that intervention, which contributed to the decline in foreign reserves, the yuan still fell 6.5 per cent against the dollar in 2016, the most in more than 20 years.
"It's normal to see fluctuations of foreign exchange reserves," the State Administration of Foreign Exchange (SAFE) said in a statement after the data was released, adding there was no need to focus on "the threshold of a round number."
Increasingly sophisticated investors in China are looking to diversify their portfolios and protect their wealth, amid general concern the yuan will keep depreciating. But the effect of the outflows is to place even more pressure on the currency. Chinese companies, too, have sought to diversify their operations overseas.
At the end of last year, China's government responded to the surging outflows by introducing a suite of measures tightening its control over foreign currency transactions. Beijing told banks to stop processing cross-border yuan payments until their monthly inflows and outflows were in balance. It also increased disclosure requirements for individuals looking to cash out their annual $US50,000 foreign exchange quotas. This includes requiring people to pledge they are not using the money to buy overseas property, securities or insurance.
For years, this micromanagement of foreign exchange transactions was unnecessary because China's problem was capital inflows rather than outflows. But that trend reversed in the second quarter of 2014.
Capital's China economist Julian Evans-Pritchard said as the $US3 trillion level was viewed as an important threshold, "this decline will likely spark renewed debate over how long the People's Bank (PBOC) can continue intervening to support the [yuan]."
"Our view is that the PBOC can afford to keep selling FX at the current pace for a long time," he said in a research note. "[International Monetary Fund] guidelines suggest that, given the scale of China's export income, broad money, foreign liabilities and its capital controls, the country's FX reserves could fall to as low as $US1.8 trillion and still offer adequate protection against balance of payment strains."
Mr Evans-Pritchard said the latest data could actually be viewed as "reassuring" because the pace of declines had eased.
"We estimate that valuation effects from fluctuations in exchange rates and bond prices will have boosted the value of the reserves by a modest $US10 billion last month," he said.
"This implies PBOC FX sales of around $US25 billion last month, the smallest amount since last August. This, in turn, hints at capital outflows of around $US45 billion, down from $US61 billion in December."
The slowing pace of outflows suggests recent tightening measures are starting to work. At the end of last year, regulators flagged greater oversight of multi-billion dollar foreign investments, particularly those that sit outside a company's "core business," as well as big real estate deals by state-owned firms. And banks were told by the foreign exchange regulator to conduct further due diligence on their clients' overseas activities, and seek regulatory approval for cross-border transfers of more than $US5 million, compared to the previous threshold of $US50 million.
China is also stepping up efforts to attract more capital with the State Council releasing a 20-point plan last month to relax foreign investment rules across its services, manufacturing and mining sectors. The plan was light on detail but the National Development Reform Commission, the country's top economic planning body, said it was revising the guidelines and would reduce the number of sectors off limits to foreign investors from 93 to 62. The NDRC also announced separately that, if foreign investment, which complied with guidelines, was less than $US300 million, local governments could give relevant approvals, helping to reduce red tape.
All of these actions signal the level of concern among policymakers about the impact of persistently large outflows on the economy. However, it may be out of the Chinese government's hands.
"Outflows may start to pick-up again later this year if, as we expect, the US dollar begins to strengthen again," said Mr Evans-Pritchard.
In recent weeks, the yuan has benefited from a weaker US dollar. On Friday, China's central bank lifted a key lending rate for the first time in six years. However, if US interest rates continue to rise, the yuan's reprieve could be short-lived.
