Analysis: Chinese banks are overflowing with dollars, and it’s worrying

Chinese yuan and US dollar banknotes can be seen in this illustration taken on February 10, 2020. REUTERS / Dado Ruvic / Illustration

  • Onshore dollar deposits exceed $ 1 trillion
  • Liquidity supports the yuan as authorities seek to temper rally
  • Traders see risk that selling dollar crushes dollar / yuan

SHANGHAI / SINGAPORE, June 1 (Reuters) – A mountain of dollars on deposit in China has become so large that banks are struggling to lend the currency and traders say it poses a risk to official efforts to control a yuan rapidly rising.

Spurred on by surging export earnings and investment flows, the value of cash deposits in Chinese banks exceeded $ 1 trillion for the first time in April, according to official data.

A previous jump in late 2017 preceded the dollar sell-off that accelerated the yuan’s sharp rise in early 2018.

Market participants claim that the size of the treasure even larger this time increases that risk and makes the efforts of policymakers to restrict the yuan vulnerable to the whims of exporters and foreign investors who own the money.

“This particular positioning, in our view, is susceptible to capitulation if the general downward trend of the dollar were to continue,” said Rohit Arora, UBS currency strategist for Asia, especially if the yuan earns beyond 6.25 or 6.2 per dollar.

“We believe that a break from these levels… has the ability to affect the market psyche,” he said, as they represent, roughly, the yuan’s peak in 2018 and its peak before a devaluation in 2015. , and trigger the sale of local businesses in particular. .

The heavily managed yuan is at a three-year high, rallying to major resistance at 6.4 per dollar, and it posted its best month since November in May.

Fearing that this rapid increase could trigger a huge conversion of deposits into yuan, the People’s Bank of China (PBOC) said on Monday that starting in mid-June, banks should set aside more reserves against them to discourage a new accumulation.

STATE CONSTRAINT

The central bank’s stance marked a shift towards confrontation with a trend that accelerated as the bank, at least publicly, stayed on the sidelines.

Since 2017, the PBOC has largely left the yuan to market forces, keeping its foreign exchange reserves (CNFXM = ECI) just above the $ 3 trillion mark, while behind the scenes state banks and private sectors stepped in.

In the 16 months ending in April, dollar deposits increased by $ 242.2 billion, according to PBOC data, an increase equal to about 1.8% in gross domestic product and greater than the much vaunted inflows. in the Chinese bond market, which totaled around $ 220 billion for the period. .

Even though the country’s trade surplus swelled during the pandemic and the banking system converted $ 254 billion into yuan for customers, the People’s Bank of China took only $ 90.2 billion from the financial system in the country. during those months.

“The private sector has overtaken the central bank to absorb excess US dollar liquidity generated by companies and inflows of foreign investment,” said HSBC global currency strategists, led by Paul Mackel, in a note released Monday. .

It could also reflect the private sector’s view that the yuan is near a peak, or that it is preparing for future payments such as dividends and overseas investment, they added.

PRESSURE

The raw economy may explain the build-up: China has the world’s largest current account surplus, and government data shows about half of dollar deposits are held by local businesses that have exploded with demand for their exports.

The same outperformance attracted global capital, which poured into a stock market (.SSEC) by taking advantage of the pandemic recovery and credit markets paying better returns than other major economies because political parameters have started to tighten.

However, these factors do little to guarantee the sustainability of the cash flow, especially as they come up against a formidable development in the dollar / yuan exchange rate, which fell by 11% in one year.

Admittedly, many forex traders believe this makes further sustained declines in the dollar unlikely. UBS’s Arora and HSBC’s Mackel both believe a dip to 6.25 to the dollar is possible, but a recovery will follow – to around current levels of 6.38 by the end of the year. year for Arora and Mackel to around 6.60 by the end of 2021.

Most also believe that the central bank will not tolerate further gains and cite the jawbone of officials to calm the rally and the decision to cut dollar liquidity, by increasing the banks’ reserve ratio, as proof of its resolve.

Onshore banking sources have said demand for new dollar loans is terrible, even at extremely low rates – and the data shows the value of deposits reshuffling fast cash bad credit in December.

“The way this has changed over the past few years has been quite phenomenal,” said Patrick Law, head of North Asian local markets and Asia undeliverable futures at Bank of America in Hong. Kong.

“Last year was the first in more than a decade or more that there were more foreign currency deposits than foreign currency loans and that the imbalance increased in 2021,” he said. declared.

The only caveat that keeps people from being too cocky – the currency has been floating for only 5 years and has only seen such a combination of growth and political settings once before. Still, global investors are keeping a cautious eye.

“The pressure is there, there is no doubt about it,” said Stuart Oakley, head of spot currency trading at Nomura in London. “There are a lot of dollars piling up on the ground.”

Reporting by Winni Zhou in Shanghai and Tom Westbrook in Singapore. Editing by Vidya Ranganathan and Barbara Lewis

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