The People’s Bank of China has been selling off foreign currency reserves at a prodigious rate to keep the RMB stable. At $3.2 trillion, China’s reserves still seem enormous. But they are down $760 billion from their 2014 peak, and $300 billion in just the past three months. As shown in the figure above, at the current pace of decline China’s reserves will, according to the IMF’s framework for reserve adequacy, actually fall to a dangerously low level in the spring. This means that China would be at risk of a balance-of-payments crisis, unable to pay for essential imports or service its dollar debt payments.
China has for years been pursuing what has been called the “Impossible Trinity”: controlling interest and exchange rates while leaving the capital account significantly open. Chinese residents are permitted to send up to $50,000 overseas annually – this is enough to allow trillions in outflows. So what can China do to staunch the rapid decline in reserves?
It could impose tighter capital controls, as Bank of Japan governor Haruhiko Kuroda controversially urged it to do. As shown in the figure, this would allow China to operate safely with fewer reserves. But it would also put a halt to China’s plans to transform the RMB into a major reserve currency.
China could also raise interest rates, which might encourage capital inflows and discourage outflows, but this would hurt growth in an already sinking economy.
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