Fair weather flows
China’s currency is a fickle measure of confidence in the country’s fortunes. For much of 2012 the yuan stagnated, causing investors to hold back on previous bets on its appreciation. Recent data suggests they have been piling back in to the Chinese currency – but that may not last.
Banks in China bought a net $93 billion of foreign currency from their clients in January, a record amount. It far outstrips the $38 billion yuan in foreign currency that entered through the trade surplus and foreign direct investment.
One explanation is that confidence in the economy has returned. Exporters are basically free to convert their foreign currency inflows when they see fit, so often time their transactions according to their views on China’s currency. When the yuan isn’t strengthening, it makes sense to hold on to dollars or euros instead. The latest shift may signal expectations the currency is about to renew its upward path.
However, the inflow is more likely to mark the end, not the beginning, of a trend. Chinese companies have been accumulating foreign currency for some time. Official data suggests exporters cashed in fewer receipts than they received in 2012, creating an overhang of $44 billion. Companies also borrowed in dollars as they took advantage of low interest rates. Since June, Chinese banks’ foreign currency loans have increased by $130 billion, while foreign currency deposits held onshore swelled by just $5 billion.
Why companies waited until January to convert is a mystery. They may have been waiting to see how China’s economy, and last year’s leadership change, would pan out. Still, January’s surge looks more like a return to a more neutral position, rather than a return to risk-taking.
There are even reasons to think the yuan may weaken. One-year forward currency contracts are pricing in 1.4 depreciation. Recent warnings that China is prepared for a currency war with Japan hardly suggest policymakers intend to let the yuan appreciate. If the currency shows signs of weakening, those who have borrowed in dollars will want their foreign currency back, and the latest inflow could once again become an outflow.