China’s foreign exchange reserves suffered another major blow in November – the largest since January – falling US$69.1 billion to US$3.0516 trillion, signaling that capital flight remains a major policy concern for the country’s monetary authorities.
The seemingly endless liquidity drain on the domestic banking system brought about by persistent capital outflows is gradually pushing money market rates higher and driving up bond yields at the fastest pace in three years. This is threatening to derail Beijing’s grand plan of reorienting its US$11 trillion economy with low financing costs.
The benchmark overnight interbank and 7-day repo rates stand at 2.29% and 2.49%, respectively, approximately 30 and 15 basis points higher than their levels in June.
Meanwhile, the onshore bond market is facing one of its most fearful tests since mid-2013, with the highly liquid 5-year and 10-year government bonds seeing yields surge to 2.91% and 3.11% respectively, up by 50 bps and 40 bps from their October lows.
However, these yields spikes are still considerably milder than those in China’s corporate bond market, where the average 5-year AAA-rated corporate yield has surged by a massive 0.8 percentage points to 3.86% in less than two months.
The latest foreign exchange reserve data from the People’s Bank of China (PBOC) confirms the notion that market fear often feeds on itself, as the rapid slide of the yuan to its weakest level against the US dollar in eight years during November drove more capital to the exit, resulting in domestic interest rates rising.
This explains why the central bank has been attempting to break the bear grip on the yuan through official rhetoric emphasizing the strength of the currency against a world basket, as well as by allowing overnight funding rates to spike in the Hong Kong offshore yuan trading center to discourage short-selling of the currency and engineer a sharp recovery during December.
China’s monetary authorities must provide dollars to the sellers of yuan as it intervenes in the forex market to prop up the value of its currency, an action that leads to a decline in its foreign currency stockpile. China’s foreign exchange reserves have declined by a quarter from the peak of nearly US$4 trillion in 2014.
In addition, the government has tightened its control on capital outflows by cracking down on illicit transfers disguised as foreign investments, which have soared to a record high this year. According to Reuters, citing anonymous sources, any overseas investment or merger and acquisition worth more than US$5 million must now seek approval from the government’s foreign exchange department. Even previously-approved large-scale investment projects will be subject to the new scrutiny. However, the question now is: are the recent PBOC moves enough to shore up the yuan and stem capital outflows?