Devaluation Forces China to Dip Into Reserves

Devaluation Forces China to Dip Into Reserves

According to the monthly forex reserve data report released by China on September 7, there was a $93.9 billion decrease in total monies reserved for forex trading during the month of August. The People’s Bank of China, which is China’s central bank, reportedly used these reserves in order to stabilize the value of the yuan (CNY) after its devaluation in the first half of the month. According to governmental data, the total reserve at the end of the month was $3.56 trillion.

Since June 2015, the value of the Chinese yuan had remained primarily stable, but since July 11 it has been significantly on the decline as compared to the United States dollar (USD). This unexpected drop in value has been somewhat stabilized due to the use of the forex reserves, but remains shaky overall. This fall was a direct result of failing stocks of companies such as China XD Plastics Company (CXDC), China Unicom Hong Kong (CHU), China Mobile (CHL), China Automotive Systems (CAAS), China Petroleum and Chemical (SNP), and China Biologic Products (CBPO). There is also a correlation to the fall of iShares China Large-Cap ETX (FXI), as this sharp decline occurred around the same time.

Traditionally speaking, forex reserves are intended to serve as a method of currency exchange between companies, with such benefits as allowing countries to pay off their debts to other countries. For countries where imports are a primary source of income, these reserves must be kept proportionate to the heavy imports. Additionally, a country can use these reserves to influence the currency exchange rate, which is directly applicable to China’s current situation.

Two-thirds of China’s reserves are based on the US dollar, in the form of government and institutional bonds. This is supplemented by the one-quarter that is held in Euros. On a global scale, two-thirds of all reserves are held in US dollars, and as such most comparisons made in respect to valuation are based on the value of the US dollar at the time of the trade. With respect to these markers, the estimated value of the CNY compared to USD was around 6.36:1.00 at the time of the reserve data report.

Overall, this depletion of reserves is of little overall impact to China; standard practice is to have a reserve value of about 3 months worth of imports, and even with the recent decline, China holds reserves that are roughly equal to the value of 2 years of imports.

The primary cause of this drop in valuation was an overwhelming number of sold shares, despite government advice. The Chinese government had hoped that discouraging these sales would prevent widespread panic, but as the yuan had been growing at an unsustainable rate, many people sold in a very short time in order to turn around their own profits. This led to a nationwide market crash in May 2015, and the government was forced to use their reserves to fix this problem.

There were secondary causes, however. Since November 2014, China has repeatedly cut interest rates in order to allow its investors to borrow at cheaper rates, and thereby promote more investment. While this was beneficial to the demand for exports, it laid the foundation for the yuan to hold a lower value. (Interest rates, while unpleasant for those who must pay them, are a valuable asset in the overall economy) Along with the reduction of the purchase manager’s index (or PMI) date, there was a markedly downward progression inevitable for the yuan.

Until this recent economic slowdown, China had been an efficient model of a growing economy that thrives on its exports and manufacturing. The government had opted against value stabilization of the yuan, instead choosing to build their reserves in case anything went wrong. This fact is likely to save China from a complete economic breakdown due to this devaluation.

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