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“The only thing that could protect Beijing from this incoming wave is a significant increase in exchange-rate flexibility. Today” Stephen Green, Standard Chartered |
As Green tried to rationalize the factors behind the outflow, he concluded that the initial estimate was likely to have been too large. And while he said there was a possibility that the country was experiencing some hot outflows, the most likely reason was trade financing.
Green says that the most recent data from the US Treasury, released on January 16, show that China is still a net buyer of US dollar-denominated assets. He argues that if the country were experiencing sizeable FX outflows, it would not be buying more treasuries but selling them. Another possible explanation is that China has used a significant slice of its FX reserves, as much as $120 billion, to restructure the Agricultural Bank of China. This theory is supported by the fact that the bank received a $19 billion capital injection from the China Investment Corporation late in 2008 and saw about $110 billion to $120 billion shaved off its balance sheet. However, Green dismisses this for a variety of reasons.
Standard Chartered says it is possible that the increase in China’s US asset holdings is as a result of buying of US treasuries by entities other than the State Administration of Foreign Exchange’s reserves bureau, or because some FX reserves have been transferred to the finance ministry. But Green argues that while all these theories have their merits, he believes that the most likely reason behind the outflows is trade financing.
According to Green, buyers of Chinese goods are likely to have extended their payment terms as they became more cash-constrained. He says that crudely adjusting the bank’s model to take this into account suggests this would have cut FX inflows, possibly dramatically, in Q4 2008 and helps explain the unexplained outflows. However, Green warns that although the scale of speculative money exiting China might not be as large as many had initially believed, it is occurring. China may face a problem later in 2009 if this money flows back in, which should not be ruled out. If that happens, Green writes: “The only thing that could protect Beijing from this incoming wave is a significant increase in exchange-rate flexibility. Today.”
