China: StanChart tries to explain FX outflow mystery
News that China experienced a severe foreign exchange outflow in the fourth quarter of 2008 came as a major surprise to most analysts and left them searching explanations. According to an initial report written by Stephen Green, Standard Chartered’s head of research for China, the unexplained outflows could have been as much as $240 billion, a figure he described as “a very big, very scary number”.
"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.