The yuan firmed against the dollar in the spot and offshore forwards markets on Tuesday, despite news of a big fall in Chinas foreign exchange reserves, after the Chinese central bank set a strong yuan mid-point. Traders took the mid-point as a signal of the central banks commitment to yuan stability against the dollar.
Chinas official foreign exchange reserves recorded their biggest monthly drop in at least nine years in January, a source familiar with the situation told Reuters on Tuesday. The source, who asked not to be identified, declined to say exactly how big the drop was. But he said provisional figures showed it was greater than the $25.9 billion fall last October, a fall that surprised markets with its size. Official data for the first quarter is expected to be released in April.
A large part of Januarys fall, from $1.946 trillion at the end of December, was apparently due to the dollars global appreciation. Assuming 40 percent of the reserves were in non-dollar currencies, the US Dollar Indexs 5.5 percent appreciation in January would by itself have cut the reserves by roughly $43 billion.
But since the trade surplus and inward direct investment totalled $46.6 billion in January, the fall in the reserves may indicate significant outflows of speculative money from China. The reserves may have dropped faster in February, when the trade surplus shrank to $4.8 billion from Januarys $39.1 billion.
Outward direct investment, which totalled around $50 billion last year, may also drain the reserves this year. Although the global crisis has made Chinese financial firms more cautious about overseas investment, some analysts think Chinese investment in foreign commodities sectors could surge this year.
Late on Monday, the Ministry of Commerce relaxed regulatory procedures to make it easier for non-financial Chinese companies to invest abroad. However, news of the January drop in the reserves had little impact on the forex markets. Spot yuan traded very narrowly between 6.8360 and 6.8372 before closing at 6.8372, up marginally from Mondays finish of 6.8381.
One-year dollar/yuan non-deliverable forwards bounced up to 6.9220 bid immediately after the reserves news from 6.9152, but they soon fell back. They were at 6.9190 in late trade on Tuesday, down from Mondays close of 6.9300. That left them near Februarys two-month low of 6.8990.
Also showing the market sees little chance of any significant drop by the yuan, one-year dollar/yuan volatilities fell to 7.40 percent bid from 7.50 percent at Mondays close, nearing a six-month low of 7.00 percent hit in late February. Traders attributed the strength of the yuan in the NDF market partly to the dollars global softness this week.
But they also saw the central banks choice of daily spot mid-point on Tuesday - 6.8327, up from Mondays 6.8349 - as a signal that China would not respond to weak economic data, such as deflation and a plunge in exports during February, by letting the yuan depreciate against the dollar.
Tuesdays mid-point was level with the reference rates peak in February; the central bank has kept the mid-point in a 6.8300-6.8399 range since mid-December. "The central banks fixing today was stronger than many of us had expected, and we think its a response to the poor trade and FDI data," said a dealer at a major European bank in Shanghai.
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