China's foreign exchange reserves fall opens reform window

A decline in China's foreign exchange reserves extended through November, providing a good chance for Beijing to speed up capital account opening, an advisor to the Chinese government said on Wednesday. Concerns about "hot money" inflows have long been cited as a reason for Beijing's caution in liberalising its carefully controlled capital account and foreign exchange regime.
But Li Yang, a deputy head of the Chinese Academy of Social Sciences and a former central bank adviser, said the concerns are no longer as potent as China's foreign exchange reserves had been falling every day for the last two months. "It provides a time window for China to speed up its necessary reforms, like capital account opening and yuan convertibility reform and even the exchange rate formation mechanism," Li told reporters.
China's foreign exchange reserves have expanded rapidly over the last decade, becoming the world's biggest in the process worth some $3.2 trillion, swollen by a huge trade surplus and strong capital inflows. The inflow has driven the yuan some 40 percent higher in real effective terms since China broke its peg to the US dollar in a 2005 landmark reform. The People's Bank of China (PBOC) has managed appreciation carefully since to prevent the exchange rate from rising too sharply while maintaining steady upside.
But the situation had changed abruptly in the last two months as money started to leave China and the yuan began to weaken against the dollar in the onshore market. It has lost around half of one percent since marking a record high to the dollar on November 14 of 6.3354.
"It's still hard to say whether these changes will become trends, but one thing is clear, one-way capital inflow or one-way bets on a yuan rise have become history," Li said. He added that China's 50 basis point cut in the reserve ratio banks are required to hold - announced on November 30 - was a move designed to cope with capital outflows and shrinking foreign exchange reserves.
"Foreign exchange reserves declined in September, October and in November - they have been falling each day," he said. Li, a former central bank adviser, did not elaborate. The central bank is due to release data on foreign exchange reserves for the fourth-quarter around mid-January.
Data on banks' currency purchases showed China had net capital outflows in October - the first such outflows in four years - when jitters over the global economy prompted some investors to withdraw speculative funds. China's foreign exchange reserves fell nearly $61 billion in September on an outflow of funds and a skidding euro. The reserves stood at $3.2 trillion at the end of Setember, still the world's largest. In terms of domestic policies, Li said China would lean toward relaxation in monetary policy implementation even though the official wording may remain as "prudent" for 2012. "Both curbing inflation and maintaining growth will be targets, but since inflationary pressures are easing and slowdown concerns are rising, priority will be given to growth," Li said.