Goldman seems to have confirmed something that I — and, for that matter, Stephen Green of Standard Chartered and Louis Kuijs of the World Bank — have suspected for a while: China's "true" reserve growth is higher than the reported number ($247b).
Goldman via Reuters and Pakistan's Daily Times:
To shield the banks from currency risk at a time of a rising yuan, the People’s Bank of China (PBOC) may have arranged a total of $40-50 billion in currency swaps with Bank of China, China Construction Bank Corp and Industrial and Commercial Bank of China at an implied yuan appreciation rate of 2-3 percent a year, the bank said. Goldman’s research is the latest attempt by PBOC-watchers to explain an apparent paradox: given China’s current account surplus last year of about $230-250 billion and foreign direct investment inflows of $63 billion, why did the PBOC’s official reserves rise in 2006 by only $247 billion?
The gap between China's reported reserves and the sum of its current account surplus and net FDI inflows is even bigger if you strip out estimated valuation gains from the reported $247b increase. China holds some euros, and those euros rose in value in 2006. If China has about 70% of its assets in dollars and say 20% in euros, 5% in pounds and 5% in yen, valuation-adjusted reserve growth was more like $220-225b. Even with $40-50b in swaps, the 2006 increase in valuation adjusted reserves ($220-225b), off-balance sheet reserve growth ($40-50b) and transfers to a large reinsurer ($4b) add up to between $265-280b. That still seems to be a bit less than the sum of the current account surplus ($230-250b) and net FDI inflows ($60-65b). There may be a few more dollars out there in someone's hands …
The use of swaps also explains why the banks have been willing to buy dollar bonds when private Chinese citizens's haven't shown comparable interest in foreign assets: they aren't bearing the currency risk. Goldman again:
Liang and Yi said it was hard to argue that banks chose to buy FX bonds on commercial grounds because they have limited FX operations and, since August 2006 when the yuan’s pace of climb started to quicken, the trade has been losing money. Furthermore, the banks’ decision to add aggressively to their FX assets contrasts with a steady drop in Chinese households’ holdings of FX assets. Just this week, Bank of China said it had closed one of the first funds through which retail investors could buy overseas bonds because of heavy redemptions.
Lang and Yi note that the total foreign assets of China's banks increased by around $70b in 2006. $40-50b of that was financed by swaps — i.e. it effectively was borrowed from the PBoC. Most of the remainder, I would guess, comes from the roughly $25b ICBC and the BoC raised in their Hong Kong IPOs. Goldman should know that data especially well. To the best of my knowledge, the PBoC hasn't allowed China's state banks to convert their Hong Kong dollars into RMB.
Kudos to Goldman's China team; this looks to be good work.