We noted last week that there was a rising tussle over dollars in China, spurred by capital outflows and RMB-denominated selling on signs that the world’s key economic powerhouse may be slowing. A situation which was arguably thrusting China into a dollar short position.
While that might seem counterintuitive given China’s substantial longer-duration dollar assets, it is possible because of China’s substantial short-term dollar liabilities. Essentially, we’re talking about a dollar-denominated duration mismatch on the mainland at a time when China is running one of its largest outstanding external debt positions for 27 years.
On Monday, Bloomberg reports that the dollar rush may be being magnified by the fact that Chinese citizens are also gathering dollar-denominated deposits at their fastest pace in five years:
May 21 (Bloomberg) — Dollar-denominated deposits in China are rising at the fastest pace in at least five years and government debt is rallying, reflecting waning confidence in the world’s second-biggest economy.
Foreign-currency deposits increased $89.4 billion in the last four months to $364.5 billion, the biggest jump in data going back to 2007, People’s Bank of China figures show.
Chinese banks sold a net 60.6 billion yuan ($9.6 billion) of foreign currency in April, reflecting capital outflows, according to a separate PBOC report.
The government’s benchmark one-year bond rallied the most in six months last week, driving its yield down 34 basis points to 2.42 percent, as property prices and foreign investment fell.
China’s currency has dropped 0.5 percent this year and waning expectations for appreciation have prompted investors to sell yuan-denominated bonds in Hong Kong, driving yields to a four-month high.
Dim Sum bonds lost 2 percent in the past year as U.S. Treasuries gained 8.9 percent, reflecting increased appetite for dollars amid Europe’s debt crisis.
And what’s really exceptional:
“Demand for dollars is rising and the central bank even has to sell dollars in the market to meet such demand,” said Li Wei, an economist at Standard Chartered Plc in Shanghai. “People’s interest in holding yuan assets will decline further because the worst of the economic slowdown is not over.”
Now if this trend (of the central bank having to sell dollars to the market) continues, it is very possible that China might eventually be forced to start selling longer duration dollar-assets.
The only alternative, as we pointed out last week, would be if China managed to internationalise the renminbi in a way that encouraged new foreign capital into the country or allowed Chinese companies to settle dollar-liabilities in yuan.
In the meantime, China could theoretically engage in swap lines with Fed as a contingency — though we presume this would be unlikely– or consider repo-ing its dollar denominated assets in exchange for short-term dollar liquidity.
This could definitely make sense if repo rates were low enough.
We’ve looked into the possibility of China doing this, and it seems there is nothing in principle that should stop it from doing so, especially if it engages via the over-the-counter markets. The reason it’s not done it before, meanwhile, is because it had little incentive to do so.
Of course, if it does engage in repos, one could expect short-term US repo-rates to stay very well supported if not rise considerably.
External debt highest since 1985: SAFE report – ChinaDaily
Why China’s RMB exodus IS the story – FT Alphaville
China equilibrium *alert* – FT Alphaville
Chinese CNH – YOURS! – FT Alphaville
China buyers defer raw material cargos – FT