First Insights:China FX reserves fall sharply in August

China’s August headline FX reserves fell by USD93.9bn m-o-m to USD3.56trn (Nomura: USD150bn; Consensus: USD71bn). Adjusting for FX valuation (namely the EUR rally) and coupon payments (from the US), we estimate FX reserves fell by more, down USD128.6bn m-o-m.

    The decline in FX reserves at first instance is likely to be viewed negatively, supporting our bias to be long spot USD/CNH. The sharp 2.6% m-o-m fall is likely to raise market concerns over the sustainability of the People’s Bank of China’s (PBoC) FX intervention. It should also support market concerns over weak economic growth, net capital outflows, the likely divergent monetary policy outlook with the US and the RMB remaining overvalued.

    However, from a medium-term perspective, even though this is a relatively sharp monthly drop in FX reserves, we believe the more positive aspect is that it could suggest that the process of foreign currency (FC) liability hedging/deleveraging has made significant progress. We judge that there has already been significant deleveraging on the FX bank loan front (see FX Insights - Chinese intervention: Non-linearity around the corner, 3 September 2015), but on FX hedging of FC liabilities, we may only be at around 50% of desired levels (private and public sector), in our opinion. This suggests that the pace of FX reserve decline (assuming there is little change in the PBoC’s FX stance and local macro/political landscape) could continue in the near term, but over the medium term we expect it to slow.