Event

China’s FX reserves increased by US$24.0bn to US$3,054bn in May, following a gain of US$20.4bn in April. In SDR terms, FX reserve holdings edged down to 2,206bn in May from 2,210bn in April.

Meanwhile, China’s gold reserves remained at 59.24mn ounces (or 1,842.6 metric tonnes) for the seventh month, with the USD value largely flat at US$75.0bn in May.

Comments

Further weakening of the USD continued to lift the dollar value of FX reserves in May. The USD index declined 2.1% in May, driven by rising cyclical strength in Europe and receding “Trumpflation” expectations in the US. More specifically, the EUR and JPY strengthened 3.2% and 0.6% against the USD, respectively, while the GBP weakened 0.5% vs. the USD. In light of the currency composition of China’s FX reserves, we have estimated that the exchange rate movements should have boosted the valuation of China’s FX holdings by around US$18bn in May.

There might have been small net FX inflows in May. Net of the valuation effect, the implied FX inflows were estimated to be around US$6.0bn in May, vs. US$3bn FX outflows in April using the same calculation. Although the average daily FX trading volume in the onshore market edged up 8.7% MoM to US$26.8bn in May, the absolute level of FX transactions still implied manageable outflow pressure. Meanwhile, the trade surplus may have expanded visibly in May to >US$50bn, driven by the seasonal factor in May and continued recovery in external demand momentum.

China’s FX reserve level may gain further in the near term. On one hand, the FX outflows have become visibly more muted in 2017, while the commercial banks started to reduce their FX positions (buying “CNY positions”) recently, partially driven by the visible widening of China-US short-term interest rate differentials. On the other hand, we expect economic fundamentals in China to remain solid – although the near-term growth may experience a “soft-patch” due to the ongoing liquidity tightening and financial deleveraging, we do not expect a prolonged period of growth slowdown and deflation following the regulatory house-cleaning. Therefore, even looking beyond the recent spike-up of CNY/USD exchange rate, we see the RMB exchange rate to be well supported by the economic fundamentals.