Foreign Exchange Forensics and China's Reserves

Foreign Exchange Forensics, China's Reserves, Forex Market, IMF, IMF reports, fx trader, forex

At the end of every quarter, the IMF reports official reserve holdings. It is the most comprehensive and authoritative source of such information. This is especially true of the currency composition of the reserves, which some countries publish freely and others regard as a national secret.

The IMF reports the figures with a quarter lag. Data as of the end of the second quarter have now been made available.  It collected data from 146 participating countries. There were 145 countries in Q1 that participated, but of special note, starting with Q2 figures, China has formally accepted the international best practices and will report its reserve figures to the IMF on a quarterly basis.

The caveat is that China only reported part of its reserve holdings, claiming that they were broadly representative of its allocation. It indicated that over the next two years, it will include more of its reserves. This may set the conspiracy-oriented among us to wonder if China has the reserves it claims, as some do about various central bank gold holdings.

Occam's Razor would suggest a simpler explanation. By gradually reporting its reserves, China can minimize the loss of secrecy. It is Chinese diplomacy. Begrudgingly (in terms of how long it has taken China to adopt this rather straight forward reporting that the vast majority of countries practice) accept the convention, but do so in China's way.

It is not exactly clear how much of China's reserves were reported. It appears to be around $550 bln. Here is how we arrive at that estimate. Some countries report the currency allocation of their reserves and others simply report their overall reserves. The unallocated reserves fell by $580.2 bln. The allocated reserves rose by $604.8 bln.

A point we keep hammering is that the reserves are not simply quantities of money, but there is a valuation component that needs to be taken into account. The IMF explains in a technical note that countries report their reserves in terms of US dollars, and the preferred exchange rate is the quarter-end rate. The fluctuation of exchange rates impacts the dollar value of reserves. Broadly speaking, a rising dollar puts downward pressure on the value of reserves, while a falling dollar lifts the valuation of reserves.

However, the dollar holdings themselves are not subject to valuation shifts. This is a pure quantity. The amount of dollars held by those central banks that report the allocation of their reserves rose by $363 bln. If we assume that China's holdings of dollars were in line with the global average (of allocated reserves), which is 63.75%, it means China reported about $567 bln of the $3.69 trillion of reserves (as of the end of June). This is broadly consistent with our earlier estimate.

The US dollar fell against all the reserves currencies in the second quarter, except the Japanese yen, which slipped 1.9%. This means that the dollar value of reserve holdings has been bolstered by the dollar's decline. For example, the value of the reserves denominated in euros rose by $105 bln or 8.3% to $1.367 trillion. The euro appreciated in Q2 by 3.9%. That means that almost half or $49 bln of the increase in the (dollar) value of euro reserves can be explained simply by change in the euro-dollar exchange rate.

In addition to including Chinese figures in the currency allocation, the IMF made another critical change. Previously it broke down the reserve holdings by what it calls advanced economies and emerging and developing economies. Apparently without explanation, the IMF says this level of detail will no longer be provided.  While the motivation may not be clear there is a clear and practical consequence. It makes it harder to interpolate the allocation of China's reserves, which is consistent with the PBOC bleeding the currency allocation of its reserves into the IMF data gradually.