China FX reserves indicate PBoC keeping powder dry

China's foreign exchange reserves increased last month, suggesting the People’s Bank of China was holding back from using its funds to help support the falling yuan.

The reserves amounted to $3,118bn at the end of July, up $5.8bn from a month earlier. The average forecast was for $3,107bn, as per Bloomberg.

China's currency, the renminbi, has fallen sharply in recent weeks against the US dollar, close to a year's low of almost ¥7.0. The PBoC took action last Friday to make it more costly to short the currency by re-imposing a 20% reserve requirement.

"One question mark heading into today was whether China was deliberately devaluing its currency for competitive advantage in the trade war," said Jasper Lawler, market analyst at London Capital Group. "In essence, a currency war. In order to deliberately devalue its currency, China would need to sell yuan into the open market by accumulating more US dollar reserves. Equally, to prop up its own currency, China needs to sell down its foreign FX reserves."

Tuesday's data suggested the fall in the value of the yuan last month may have been led by market forces, not government intervention, with the selling being ‘tolerated’ by the central bank. The currency was up 0.4% versus the greenback on Tuesday to 6.8271.

The fact that the headline reserves increased doesn’t mean the PBoC purchased currency last month to push down the value of the renminbi, said Julian Evans-Pritchard, China specialist at Capital Economics.

"More likely, the increase simply reflects valuation effects from a rise in the price of the foreign bonds held by the PBoC. That said, today’s figures do suggest that the PBoC probably did not deploy its FX reserves to defend the renminbi last month."

Markets will know with more certainty once the central bank releases its July balance sheet data in a couple of weeks’ time, Evans-Pritchard said, adding that the re-imposition of banks' reserve requirement suggests the PBOC is now starting to intervene more aggressively and more publicly in a bid to stabilise the currency.

Given this, he forecasts the renminbi will end the year at 6.80 against the dollar, broadly in line with where it is trading now