SHANGHAI/SINGAPORE—A mountain of dollars on deposit in China has grown so large that banks are struggling to loan the currency and traders say it poses a risk to official efforts to control a fast-rising yuan.
Boosted by surging export receipts and investment flows, the value of foreign cash deposits in China’s banks leapt above $1 trillion for the first time in April, official data shows.
A previous jump, late in 2017, preceded heavy dollar selling which turbocharged a steep yuan rally in early 2018.
Market participants say the size of the even bigger hoard this time raises that risk, and leaves policymakers’ efforts to restrain the yuan vulnerable to the whims of the exporters and foreign investors who own the cash.
“This positioning in particular, in our view, is susceptible to a capitulation if the broad dollar downtrend were to continue,” said UBS’ Asia currency strategist Rohit Arora, especially if the yuan gains past 6.25 or 6.2 per dollar.
“We think a break of these levels … has the ability to affect the market psyche,” he said, since they represent, roughly, the yuan’s 2018 peak and its top before a devaluation in 2015, and trigger selling from local corporations in particular.
The heavily managed yuan is at three-year highs, having rallied through major resistance at 6.4 per dollar, and it clocked its best month since November in May.
Concerned this rapid rise could unleash huge conversion of the deposits into yuan, the People’s Bank of China (PBOC) said on Monday that from mid-June, banks must set aside more reserves against them to discourage further accumulation.
The central bank’s stance marked a shift towards confronting a trend that gathered steam while the bank had, publicly at least, kept to the sidelines. Since 2017, the PBOC has largely left the yuan to market forces, keeping its currency reserves just above the $3 trillion mark, while behind the scenes the state-bank and private sectors stepped in.
Over the 16 months to April, dollar deposits rose by $242.2 billion, PBOC data shows, a rise equal to about 1.8 percent of gross domestic product and bigger than the much-vaunted inflows into China’s bond market, which totaled about $220 billion for the period.
Even as the country’s trade surplus ballooned during the pandemic and the banking system converted $254 billion into yuan for clients, the People’s Bank of China drained just $90.2 billion from the financial system over those months.
“The private sector has overtaken the central bank to absorb excess U.S. dollar liquidity generated by the corporates and foreign investment inflows,” said HSBC’s global FX strategists, led by Paul Mackel, in a note published on Monday.
That could also reflect the private sector’s view that the yuan is near a peak, or that it is preparing for future payments such as dividends and overseas investment, they added.
Raw economics can explain the accumulation: China is running the world’s largest current account surplus, and government data shows about half the dollar deposits are held by local companies that have boomed with demand for their exports.
The same outperformance has attracted global capital, which has poured into a stock market riding on the pandemic recovery and credit markets paying better yields than other big economies because policy settings have begun to tighten.
Yet these factors provide little guarantee of the cash pile’s longevity, especially as they meet with a fearsome shift in the dollar/yuan exchange rate, which has fallen 11 percent in a year.
To be sure, plenty of currency traders think that makes sustained further dollar drops unlikely. UBS’ Arora and HSBC’s Mackel both reckon a drop to 6.25 per dollar is possible, but that a recovery follows—to around current levels of 6.38 by year’s end for Arora and for Mackel to around 6.60 by the end of 2021.
Most also reckon the central bank will not tolerate further gains and cite jawboning from officials to cool the rally and the move to tamp down on dollar liquidity, by raising banks’ reserves ratio, as evidence of its resolve.
Onshore banking sources said that demand for new dollar loans was dire, even at rock-bottom rates—and data shows the value of deposits overhauling loans in December.
“How this has changed over the past few years has been quite phenomenal,” said Patrick Law, head of north Asia local markets and Asia non-deliverable forwards at Bank of America in Hong Kong.
“Last year was the first in over a decade or more, that there were more foreign currency deposits than foreign currency loans and that imbalance has grown in 2021,” he said.
The one caveat that stops people from being too presumptuous—the currency has been a floating one for just 5 years and has seen such a combination of growth and policy settings only once before. Still, global investors are keeping a wary eye.
“The pressure is there, there’s no question about that,” said Stuart Oakley, head of cash currency trading at Nomura in London. “There are a lot of dollars building up onshore.”