“China Finds $3 Trillion Just Doesn't Pack the Punch It Used To,” a Bloomberg headline from Friday morning reads.
“China’s $3 trillion-plus in foreign currency reserves, the biggest such stockpile in the world, would seem to be a gold-plate insurance policy against the country’s current market chaos, a depreciating currency and torrent of capital leaving the country,” Bloomberg writes, before citing a number of sources who say that in reality, $3 trillion aint what it used to be.
“Some Chinese reserves may have already been committed to fund pet government projects like the Silk Road fund to build roads, ports and railroad across Asia or tens of billions in government-backed loans to countries such as Venezuela, much of which is repaid through oil shipments,” the piece continues. “Then there are other liabilities that China needs to cover, such as the nation’s foreign currency debt to finance and manage imports denominated in overseas currencies.”
As we discussed at length on Thursday, Beijing burned through its UST stash at the fastest pace on record in December, liquidating some $108 billion in reserves in a desperate attempt to manage capital outflows and the yuan devaluation.
"The paradox that China finds itself in is that as it devalues the currency in what it hopes is a controlled fashion, the FX outflows soar, forcing the PBOC to intervene and slow down the devaluation, leading to a self-defeating process in which China not only devalues far slower than it hopes, but results in an accelerated depletion of reserves," we said, summing up the decidedly unenviable position the PBoC finds itself in as Beijing wades into the global currency wars.
“As expectations around the direction of RMB have shifted, so have capital outflows risen forcing the central bank to sell large amounts of reserves to defend the currency – a phenomenon that generates the opposite impact of global QE,” Deutsche Bank wrote, in a note out Thursday. “From this perspective, the ongoing large capital outflows as evidenced by the release of China’s FX December reserves today do not bode well for this year,” the bank warns, adding that its Asia FX strategists "have recently conservatively estimated that there are an additional $300bn of potential to go.”
So given the above, just how precarious is the situation? That is, with capital flooding out amid market-wide confusion over the pace of the yuan deval, soaring NPLs, M2M losses on the PBoC's CNY1.5 trillion stock portfolio (a quarter of which was purchased at multiples of 40X or more), as well as the myriad other factors listed above, one wonders how much dry powder China actually has.
A simplified way of looking at the situation is presented by RBS' Alberto Gallo, who takes FX reserves, adds an additional 20% of GDP in funds raised from issuing government bonds and compares the total to NPLs, national team losses, losses on SOE bailouts, and capital flight.
"The Chinese government has some ammunition left, but not that much considering losses already present in the economy," Gallo writes. "Comparing current central bank reserves and headroom to add to government debt vs bank non-performing loans (which we estimate at 15%), potential losses on stock purchases and capital flight over a period of three years, our simplistic comparison below tells you that China’s government dry powder isn’t that much."
And that's probably a generous assessment. That is, it's easy to imagine that NPLs are actually far higher than 15%. It's also conceivable that many more SOEs run into trouble in 2016 than 2015. Then there's the CNY8 trillion wealth management product black swan which could force the government to choose between bailing out WMP investors and facing social upheaval.
Finally, as noted above, the plunge protection national team wasn't exactly bargain shopping during the ill-fated attempt to shore up China's faltering equity market over the summer. Have a look at the following table from BofAML which shows you just how expensive some of the shares were:
The inevitable conclusion from RBS: "Chinese authorities will need to use their ammunition wisely."
We close with a warning from Richard Jerram, the chief economist at the Bank of Singapore:
"The burn rate has been worrying. It’s not about how long it gets to zero, its about how long it gets to about 2, which is what they need."