Where is China? The puzzling q1 COFER data on global reserve growth
China reported a $135.7b increase in its reserves in q1.
China doesn’t report the currency composition of its reserves to the IMF. Its reserve total consequently usually appears in the “unallocated” line of the IMF’s data on foreign exchange reserves (The COFER data).
But unallocated reserves only increased by $107b in q1. It is unusual — as the following graph shows — for the increase in unallocated reserves to be smaller than the increase in China's reserves. It happened in q4 2005, but that is about the only case, at least the only recent case apart from q1 2007.
China is clearly the most important country that doesn't report data on the currency composition of its reserves to the IMF, but it isn't the only one — and the others generally have been adding to, not subtracting from, China's total. One explanation for the q1 data is that some of these other countries reduced their reserve holdings, offsetting the very large increase in China’s reserves.
But I track the reserve data released by a lot of countries, and I haven’t found many with falling reserves recently — so I certainly wasn't expecting a big offset to China's reserve growth. Venezuela’s reserves did dip a bit in q1, but not enough to offset China’s $135b increase. If any one knows of another country that reduced its reserves significantly in q1 2007, do tell – the $30b fall in reserves needed to offset China's strong q1 is large enough that it should be relatively easy to find.
The increase in “allocated” reserve reported by emerging economies – that is emerging economies that report data on the currency composition of their reserves was $131.4b. Another possible explanation for the smaller-than-expected increase in "unallocated reserves" is that some countries started to report the currency composition of their reserves, shifting from “allocated” to “unallocated.”
Clearly something happened. I like it when various numbers line up. And right now, they aren't adding up for q1. Not only was the increase in unallocated reserves in the IMF data below expectations, but the overall number was a bit lower than expected. The reported increase in the reserves of the countries Christian Menegatti and I track topped the reported increase in the COFER data, which is a bit unusual. Usually the COFER total is a bit higher, as it picks up more countries.
Nonetheless, the COFER data makes it quite clear that the world's central banks provided the US with a lot of financing in the first quarter.
The COFER data showed a $264b increase in reserves. I usually add in the increase in the foreign assets of the Saudi Monetary Agency, which brings total reserve growth – absent any adjustments for valuation — up to $275b.
After adjusting for the impact of valuation changes (the euro rose in value, increasing the dollar value of existing euro holdings, Christian Menegatti and I estimate that total reserve growth implied by the COFER data – on a flow basis – was around $257b. An estimated $176b of that flowed into dollars, while an estimated $81b flowed into other currencies.
That estimate though hinges on a guess about the currency composition of the reserves of those countries that do not report data on the currency composition of their reserves, along with Saudi Arabia. We estimate that they accounted for $88b of the increase in dollar reserves, and $26b of the increase in non-dollar reserves.
We know that the reporting industrial countries increased their reserves by about $20b, and also increased their dollar reserves by about $20b (think Japan). The rise in industrial countries euro reserves not explained by the rise in the euro all came from a fall in yen reserves. The emerging economies that do report added $68b to their dollar reserves, and $58b to their non-dollar holdings – a rather sizeable flow into non-dollar currencies that brought the dollar’s share of their reserves down just a bit.
That slight fall makes sense to me. We know that Russia now targets a roughly 50% dollar share of its reserves – and India has long maintained a diverse portfolio. Both were adding to their reserves at a decent clip in the first quarter …
The $176b estimated dollar flow in the COFER data tops the $147b in official inflows in the US data (the US data in theory also includes flows from sovereign wealth funds, but in practice, it doesn't pick them all up — flows from the Gulf are always a bit on the low side). However, the increase in dollar reserves implied by the COFER data doesn't exceed reported inflows by much — which is a bit unusual.
Moreover, the $147b in recored inflows in q1 looked low to me as well, as the increase in the Fed’s custodial holdings of Agencies and Treasuries in q1 ($128b) was higher than the increase in official holdings of Agencies and Treasuries in the BEA data ($106b). That doesn't make any fundamental sense (though it is explained if some central banks buy in London and then hand their securities over to the New York Fed, as seems to be the case).
All in all, I am a bit confused by the IMF’s data this time around. The set of countries that I track added $314b to their reserves in q1 ($136b from China). That total includes Saudi Arabia, absent any adjustment for valuation changes. But if you take Saudi out, there still was a $301b increase – more than the $264b increase in the IMF data. And the IMF data set includes more countries.
Combine that with the difficulties finding China’s $135b reserve increase in the IMF data set and I am frankly a bit puzzled. I was expecting a somewhat stronger number.
Remember, the growth in the FRBNY’s custodial holdings accelerated sharply in q1 — something that generally indicates an acceleration in overall reserve growth. I am not as convinced as Terrence Keeley of UBS that Asia and the Middle East are unwilling to put their reserves in euros — those countries that have been willing to finance aging europe rather than aging America have been rewarded, and far more countries are increasing their euro and pound allocation than increasing their dollar allocation. But I fully share his assessment that there has been a lot of central bank buying of dollar bonds this year — at least until June, when there does seem to have been something a slowdown.
I am digging a bit deeper – I want to understand why China’s $135.7b q1 increase doesn’t seem to appear in the IMF’s data. If I find out something, I’ll let you know.
China said it uncovered illegal activities involving $2.04 billion at three of China’s largest banks, as well as poor oversight on lending to real-estate projects and in foreign-exchange transactions.
Bank of Communications plans to systematically grade the creditworthiness of its 40 million retail customers and cardholders for the first time.
China Passes a Sweeping Labor Law
http://www.nytimes.com/2007/06/30/business/worldbusiness/30chlabor.html?hp
One more step towards rebalancing, if it gets enforced.
The contemplated SIC of China will probably lock China’s MOF into a position against speedy exchange rate adjustment. The current plan seems to be borrowing $200B worth of RMB from the domestic market in the name of the treasury. Such a large fund, let’s say, can expect maybe 8-9% return as pension funds would. Let’s say its cost of capital in RMB terms will be around 4-5%. So if RMB appreciates faster than 4% it will not make any profit — but it is supposed to be a profit seeking entity. Of course the SIC is only a small piece of the whole national interest, but with its tie to the MOF it could be a powerful voice.
It seems it would be better for the SIC to directly borrow in foreign currencies since its stated goal is investment overseas. Problem is MOF is trying to also reduce domestic liquidity in the same move, and it is doubtful if enough domestic investors will be willing to lend in USD or Euros. If it borrows overseas that doesn’t help the liquidity situation at home. China’s Yu Yongding has cautioned the MOF to think through its scheme. It may be wiser to leave the liquidity management to the PBoC alone.
HZ: In china, MOF and PBoC have the same boss. They are just two hands of the premier.
jye,
The question is agency and interest alignment. SIC as a for profit entity will probably pay its employees partly based on its investment performance. PBoC is on the state budget so profit from the reserve holdings, while nice, doesn’t really tie into its policy making, or at least one should hope so. At a minimum, its governors and employees don’t have personal interests tied to the reserve income. That is not true for the SIC. If SIC really borrows RMB and invest in Fx assets to make a profit, its managers will have strong personal interests linked to RMB/Fx rate.
I would think that the SIC managers incentives should be set up so that they are rewarded for outperforming a dollar or euro benchmark — not for producing positive rmb rates of return. the rmb/ $ and rmb/ euro is out of their control — and the SIC realistically is about minimizing losses (on the rmb move) as much as maximizing returns.
A separate question — does anyone know of an emerging economy (other than vennie) that reduced its reserves in q1? I am puzzled by the COFER data, and one potential answer is an emerging economy that shifted reserves to an investment co or otherwise did something that lowered the unallocated total below China’s plus 135b.
I don’t understand all the fuss about China’s SWF - both its yuan borrowing and investment activity. It will be just another state institution managing what are effectively foreign exchange reserves. The yuan it borrows would have been borrowed by the central bank in sterlisation bills anyway. It seems unlikely that the SWF will be allowed to run different currency exposure from SAFE - otherwise it could force SAFE to offset its currency moves. The main difference I expect the SWF to make is to invest in a wider range of investments than SAFE, particularly less liquid ones, such as private equity (hence the Blackstone stake) and maybe hedge funds, and ones that public sector fund managers are not used to, such as equities, commodities and property.
RebelEconomist on 2007-06-30 15:16:04
Well put … totally agree.
Brad,
I agree it can be done if the MOF buys Fx with its RMB borrowing, retains the currency risk and contributes Fx as equity capital. However my understanding is that the legislation authorizing the bond calls it a special bond and stipulates that it will be paid off through investment income. It can be done but without careful consideration it could embed misalignment of interests somewhere in the chain.
RE/Guest,
Of course it makes no difference to China as a whole how this thing is set up, but imagine if somehow the PBoC governors and staffs’ salaries are tied to the balance sheet at the PBoC, what kind of policy recommendations do you think will come out of the PBoC then? The SIC will be a separate profit seeking entity, meaning it will not operate out of the state budget. How they earn their money will certainly determine their view and they will have powerful tie to the MOF.
HZ on 2007-06-30 19:57:21
Your phrase ‘careful consideration’ may be the key.
PBOC is a macro risk manager of FX and domestic monetary policy. Management motivation and policy must be driven by this. To the extent ‘return’ is a factor in assessing management results, it must be a macro interpretation, beyond the isolated result of the PBOC balance sheet.
SIC is an investment manager, constrained by FX and domestic monetary policy parameters, as determined by PBOC. Whatever its balance sheet structure, investment performance can only be measured fairly by focusing on the asset risk and return, ex the complications of FX and domestic monetary policy complications of PBOC policy. It’s investment management effectiveness shouldn’t necessarily measured according to its accounting result.
“…The Government of Singapore Investment Corporation, Abu Dhabi Investment Authority and other sovereign wealth funds are unquestionably sophisticated and growing factors in the markets… Collectively, however, these funds still own less than 2 per cent of the globe’s financial assets, or less than a third of that managed by insurance companies… Central banks are banks - that is to say, against all of their assets they maintain liabilities. A sound banker minimises currency mismatches on his/her balance sheets - something few central banks actually do. Potential foreign currency trans-action losses that certain Asian and Latin American central banks now face could be as high as 3, 6 or 9 per cent of their country’s gross domestic product. How might markets react if the Federal Reserve were to announce it had lost $1,000bn in foreign currency translations, the relative equivalent that some nations are now facing? …sovereign investors need to ask themselves an even tougher question: how can they be dominant players in the foreign exchange and fixed-income markets and guardians of financial market stability at the same time?” http://www.ft.com/cms/s/98e38d92-25dd-11dc-b338-000b5df10621.html
Guest on 2007-07-01 05:38:54
‘Myths’ 3 and 4 are only in the mind of the writer of that article.
(The first 2 regarding the dollar and bonds are legitimate points).
I think the point in myth four is actually right — central banks have a big currency mismatch on their balance sheet that will generate big losses. i wouldn’t characterize this as bad financial management per so tho, as the losses typically reflect a policy (fx intervention to limit appreciation) imposed on the central bank by other policy makers.
bsetser on 2007-07-01 09:31:07
Quite agree with your point.
But it is silly for the writer of the article to mischaracterize CBs as ‘investors’ per se - they’re risk managers. Nor is there any reason to fault them for running currency mismatches per se - that is the essence of FX reserve management.
The writer is attributing fault to normal function.
Now the massive size of some reserves and the motivation behind such size is something else - there it should be open season on criticism.
(And to stretch one point concerning the writer’s Fed reference, one might instead fault the Fed for earning low CB profits, when it kept rates so low -i.e. lower earnings against a 0 cost monetary base. The incremental cost of running low rates in this sense could be viewed as a type of direct interest rate subsidization to borrowers (at a cost to the taxpayer) somewhat even if vaguely comparable to China’s FX subsidization.)
Guest on 2007-07-01 13:28:35
Not quite…….to lower interest rates, the Fed buys more bonds and expands its balance sheet, so it should make more money for the taxpayer, not less.
But I am glad to see someone else taking an interest in monetary policy operations and their implications……I have pointed out in previous comments that the Fed is actually the largest central bank owner of US treasuries. Greenspan could have found part of the answer to his condundrum in the Fed internal telephone directory if he had looked. As far as I can tell, the people who pay are the holders of existing base money, which gets a bit diluted when the Fed supply more, and future buyers of interest bearing assets, who get a lower return because of competition from the Fed.