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IMF Politely Asks China To Explain Exactly How Large Its FX Forwards Book Is
03-21-2016, 07:12 PM,
IMF Politely Asks China To Explain Exactly How Large Its FX Forwards Book Is
IMF Politely Asks China To Explain Exactly How Large Its FX Forwards Book Is

<p dir="ltr">On the heels of China’s move to devalue the yuan on August 11, the market’s attention abruptly shifted to something we’d been discussing for quite some time. Namely, China’s rapidly depleting FX reserves.</p> <p dir="ltr">The problem for China was that they wanted to devalue, but they wanted to do it on their terms and that’s not something that was particularly agreeable to the market. What was immediately apparent to us, but what it took weeks for most observers to understand, was that the PBoC actually transitioned to an FX regime that afforded the market <em>less</em> of a role in determining the exchange rate, not more. Before, China would reset the daily fix to dictate where the spot traded. In the new system, the PBoC simply manipulates the spot in order to dictate the fix, which from August 12 was supposed to “better reflect” the previous day’s trading. But if the previous day’s trading was dictated by PBoC intervention, then the entire endeavor is meaningless.</p> <p dir="ltr">Of course daily spot interventions cost money. Lots of it. Especially if the market smells a rat and thinks you may be angling for a larger devaluation down the road but are unwilling to just rip the band-aid off and move to a free float now.</p> <p dir="ltr"><strong>China <a href="">blew through</a> nearly $100 billion in the month of August alone</strong> supporting the yuan and soon enough, FX reserve data out of Beijing became the market’s new <a href="">risk on/risk off trigger</a>. The data also became a rather public proxy for capital flight and before long, China got uncomfortable with the amount of attention the headline figure received.</p> <p dir="ltr">So, the PBoC decided to find other ways to intervene to both support the onshore spot and ensure that the CNY/CNH spread didn’t widen too much (the weaker the offshore yuan trades relative to the onshore spot, the more depreciation pressure there is). <strong>Dabbling in forwards became one of the bank’s go-to strategies</strong>.</p> <p dir="ltr">What Beijing has been doing actually isn’t all that complicated. <strong>The PBoC simply asks policy banks to borrow dollars in the swap market, sell them, and then enter into a forward contract with Beijing which effectively squares the trade for the banks as the PBoC takes everything onto its own balance sheet.</strong>&nbsp;</p> <p dir="ltr"><a href=""><img src="" width="600" height="312" /></a></p> <p dir="ltr">The problem is that this makes it difficult for the market to get a read on capital outflows and on how much downward pressure the RMB is experiencing (and obscuring those two things is precisely the point for China). And it’s not just the market that’s having a hard time reading the tea leaves, <strong>it’s the IMF as well.</strong></p> <p dir="ltr"> “The International Monetary Fund is <strong>pressing China to disclose more data on its currency operations</strong> according to the standards the Chinese central bank pledged to follow,” <a href="">WSJ reported</a> on Monday. Here’s more:</p> <blockquote><div class="quote_start"> <div></div> </div> <div class="quote_end"> <div></div> </div> <p dir="ltr"><em>In recent months, the People’s Bank of China has increasingly turned to the derivatives market to help prop up the currency—a shift from its traditional approach of dipping into its dollar pile to buy yuan.</em></p> <p>&nbsp;</p> <p dir="ltr"><strong><em>The new tactic has several advantages for the central bank: It allows it to burn through its foreign-exchange reserves more slowly and drain smaller amounts of yuan from the financial system at a time of economic slowdown. It also leaves less evidence of intervention.</em></strong></p> <p dir="ltr">&nbsp;</p> <p dir="ltr"><em>Currency traders and investors, however, complain that the strategy is making it even harder to figure out Beijing’s intentions for the yuan. Now, <strong>the IMF is calling on the Chinese central bank to release more data on its holdings of derivatives such as forwards</strong>—which have become the main financial instrument used by the PBOC for currency intervention these days, the people said.</em></p> <p dir="ltr">&nbsp;</p> <p dir="ltr"><em>The step would be in keeping with China’s pledge in October to adhere to the IMF’s special-data-dissemination standards as part of its effort to win the yuan its long-coveted reserve-currency status. Disclosing the data could also shed more light on how much firepower China has to keep defending the yuan.</em></p> <p dir="ltr">&nbsp;</p> <p dir="ltr"><em><strong>The data being sought by the IMF concerns the total holdings of forwards and futures by the PBOC</strong>, according to the people. Such data sets reflect future claims to a country’s foreign-exchange reserves; many of the world’s central banks, including those of Thailand, Malaysia and&nbsp;</em><em style="font-size: 1em; line-height: 1.3em;">India, have frequently disclosed this data to the fund.</em></p> <p>&nbsp;</p> <p><em>Some market participants estimate that China’s current holdings of forwards range between $150 billion and $300 billion.</em></p> </blockquote> <p>You really needn't think too hard about all of the above because there are two very simple takeaways: 1) the IMF is going to hold China to its promises of transparency and market oriented reforms now that the Fund has agreed to include the yuan in the SDR basket, and 2) these have to be settled at some point, so just know that the strategy outlined above is just about near-term optics.&nbsp;</p> <p>Perhaps Citi summed it up best last autumn: "If you have a transaction that settles down the road, the actual liquidity impact in the short term may not be as dramatic. Down the road you can’t avoid it."</p> <p>You can see why the IMF and the market more generally want full transparency out of Beijing and given the fear of capital flight, you can probably also understand why China would want to adopt strategies that make the PBoC's FX intervention as opaque as possible. Unfortunately for the PBoC, the IMF looks set to play the SDR trump card.</p> <div class="field field-type-filefield field-field-image-teaser"> <div class="field-items"> <div class="field-item odd"> <img class="imagefield imagefield-field_image_teaser" width="970" height="505" alt="" src="" /> </div> </div> </div><br clear='all'/><br/><br/><a href="" rel="nofollow"><img src="" border="0"/></a><br/><br/><a href="" rel="nofollow"><img src="" border="0"/></a><br/><br/><a href="" rel="nofollow"><img src="" border="0"/></a><br/><br/><a href=""><img src="" border="0"/></a><img width="1" height="1" src="" border="0"/><img width='1' height='1' src='' border='0'/><img src="" height="1" width="1" alt=""/>

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