Remember the days when Chinese banks used to routinely drain dollars from Chinese corporates? The days when the Chinese corporate sector was a net dollar seller?
Those days, it seems, may have very abruptly come to a halt.
Consider the following chart from Standard Chartered on Tuesday. It makes quite an impact (specifically the light blue component):
At best, the chart shows that China’s dollar position has become balanced over the last half year. That the dollars China takes in through exports cover the country’s dollar import costs, but that’s all. There are no surplus dollars leftover for reinvestment.
This, by the way, is how Standard Chartered’s analysts interpret the data.
They say it’s significant because it shows that we are “in a different world than in 2005-11”.
At worst, however, the chart implies that the banking sector’s dollar purchases could be turning negative on a net basis. That, as a result, the dollars China raises through exports are no longer enough to cover its dollar import costs. That China’s corporate sector is experiencing a dollar shortage.
The nearest we came to this scenario before was back in 2008. And even then net dollar purchases never went negative. The fact that they did earlier this year, is thus somewhat worrying in our opinion.
Most analysts seem to disagree. They believe the new-found dollar balance may be the result of China’s move towards exchange rate flexibility, a move which has allowed the renminbi to achieve equilibrium status versus the dollar.
The cause and effect is thus different in our interpretation. (We, on the other hand, *believe* China’s move towards exchange rate flexibility may be the result of its growing dollar shortage, since there is no need to keep pegging if dollar inflows are retracting.)
That said, Standard Chartered do observe the following point about corporate China’s new relationship with the dollar. It’s clear they want to hold more dollars than they did before:
Figure 2 shows the big spikes in importers’ USD buying activity in late 2008 and late 2011, when expectations of CNY depreciation hit. This ratio has not fallen back to its historical average, but it rebounded in April-May. It seems that corporate China wants to hold a few more dollars.
And have a look at the import conversion ratio:
So why this need for dollars?
Evidently because the corporate sector is carrying a sizeable dollar short position. As Standard Chartered notes (and we recommend the following as a MUST READ):
Over time, firms in China’s tradables sector have built a “short USD‟ position. In theory, over time, exporters and importers together should have net-sold dollars equivalent to the country’s trade surplus. However, we find that corporate China has actually sold many more dollars than that; we show the accumulated “excess” of USD selling in Figure 3.
This can be viewed as corporate China’s “short dollar” position. We wonder a bit about the accuracy of these numbers, but the trend is important. If corporate China was deleveraging this position, we would see a lot more USD buying in the onshore FX market and much more CNY weakness.
We believe setting off such a deleveraging process is something the People‟s Bank of China (PBoC) would very much prefer to avoid (more on this below).
However, the data suggests that corporate China kept its position more or less stable during the January-May period. The banks conduct much less FX business with corporates engaging in capital account transactions (such as direct investment). But within the capital account, corporate USD purchases are also balanced with USD sales, as Figure 4 shows.
It is possible, of course, that some „hot‟ money is seeping through both the current and capital accounts .
We close with one final thought. Dollar demand from corporate China is finely balanced and, as we have argued before, it can be impacted a lot by changing CNY appreciation expectations. Up until mid-April, the PBoC was quietly intervening in the onshore FX market to buy/sell dollars. However, we believe that the central bank has been largely absent since then (with the exception of possible intervention on 25 June and last week).
And finally the point we’ve been making about exchange rate flexibility, and who exactly it really benefits:
“Window guidance”, though, is still present via the daily USD-CNY fixing. As Figure 5 shows, the daily USD-CNY trading range (which is reflected in the end-of-day rate) is now significantly different from the morning “fix”. As such, the fix published by the PBoC is holding the market back from further CNY weakness. Think of the fix as an elastic string that the central bank uses on the market, allowing some freedom for the market, but preventing USD-CNY from drifting further up.
We previously expected the PBoC to intervene if the traded rate were to move up towards 6.4, which it presumably would if there was an external shock and/or a big risk-off move in the markets. On 25 June, without a big shock hitting the market, USD-CNY weakened to 6.3787 in the morning session; in the afternoon, it made a big move down to 6.3609, which some traders believed was driven by intervention. There is also talk of quiet intervention twice last week via primary dealers. The concern for the central bank is that more CNY weakness would further shift onshore expectations and influence corporate China‟s conversion ratios, which would in turn lead to further CNY weakness. The PBoC would much rather keep things stable for the moment.
Which is to say, the PBoC may be furiously intervening to prevent further renminbi weakness and further dollar shortages. The flexibility is, as we suggested, thus a means to prop up the renminbi rather than a means to become more internationalized.
So, does that mean we can assume net dollar purchases would not necessarily have rebounded into positive territory had the PBoC not intervened in this way? We think, very possibly, the answer is yes.
Next month’s data will be crucial in establishing a trend.
As to what else may have played a part in plugging China’s dollar shortfall in the last month? We think stories like:
Chinese buyers default on coal iron ore shipments – trade –Reuters
Chinese data mask dept of slowdown, executives say – New York Times
Coal inventory at Qinhuangdao port hits record – SteelGuru
Hot Copper shorts burning commodity firms – Caixin online
Chinese coal, iron ore defaults prompt mystery – FT
After all, what options does a Chinese corporate without enough dollars to pay for its imports have?
Delaying delivery or defaulting on payment are definitely two.
Why China’s RMB exodus IS the story – FT Alphaville
LME snapped up by Hong Kong Exchanges – FT Alphaville
China equilibrium *alert* – FT Alphaville
Chinese CNH – YOURS! – FT Alphaville
China’s ’1 per cent’ risk – FT Alphaville
China’s mega dash for the dollar – FT Alphaville