A tale of two Asias: China, and almost everyone else

Many emerging Asian economies -- Korea, India, perhaps some others -- are now intervening to keep their currencies up rather than trying to hold them down. Raphael Minder of the Financial Times reports:

South Korean authorities on Tuesday sold as much as $1bn to shore up the won, according to currency traders in Seoul, underlining concerns in several Asian countries about weakening currencies in the face of oil-fuelled inflation ... South Korea’s predicament is shared by other Asian nations that have seen an abrupt currency reversal compound inflationary pressures as oil and food prices remain near record highs.

Other Asian central banks likely sold dollars as well. An Indian newspaper reports:

" Central banks across Asia region likely to have intervened in the foreign exchange markets. The Bank of Korea, Bank of Thailand, Banko Sentral ng Pilipinas and Reserve Bank of India are all suspected to have sold US dollar to boost domestic currencies in order to contain inflation," Sherman Chan, Economist, Moody’s Economy.Com said."

China, like many other emerging Asian economies, imports oil. but it otherwise is in a rather different position than many other Asian economies. The hike in oil prices has yet to put much of dent in its trade surplus. Its larger current account surplus is expected to remain constant in dollar terms this year. And its central bank is still buying dollars, not selling dollars.

If the latest leaked data is accurate, China reserves increased by $40 billion in May. I would estimate that China bought about $44 billion in the market, after adjusting the $40 billion total to reflect a slight fall in dollar value of China’s exiting holdings of euros in May. $44 billion (over $500 billion annualized) is a huge sum. But it likely leaves out another $22 billion that China’s banks accumulated, as China’s central bank continues to ask China’s state banks to meet their (rising) reserve requirement by holding dollars rather than renminbi. $66 billion -- almost $800 billion annualized -- is a very big number.

It is a smaller than the $75 billion increase in China’s reserves in April -- a number that rises to $80 billion after adjusting for valuation gains and rises to above $100 billion if the April rise in China’s reserve requirement is factored in. Slowing down the pace of RMB appreciation in April (it has subsequently picked up somewhat) may have helped slow the pace of hot money inflows -- or China’s efforts to tighten the enforcement of its capital controls may have had an impact.

But Michael Pettis is right. The overarching story is that China’s reserves and foreign assets continue to increase at a stunning pace. Throw in another $45 billion in June reserve growth, and the increase in China’s reserves -- after adjusting roughly for valuation effects -- in the first half of 2008 could approach $290 billion.

I would round that up to $300 billion. That is roughly as much as India, the emerging Asian economy with the second highest reserves, has in the bank. Michael Pettis -- drawing on work by our mutual friend Logan Wright -- has estimated that China’s adjusted reserve growth in the first five months of 2008 was about $435 billion. To get that total, he assumed China transfered $75 billion to the CIC in q1 and that the banks have added $90 billion to their dollar holdings to meet their reserve requirement. China hiked its reserve requirement again in June. My own projections would net out some valuation gains in a way that would reduce the increase over the first five months of 2007 to around $410 billion. But that is still an absolutely huge number.

It consequently isn’t unrealistic to project that China’s adjusted reserve growth for the first half of 2008 could be close to $500 billion. Then double that number. The 2008 increase in China’s reserves, bank reserves and CIC could match Japan’s total stock of foreign exchange reserves. And not so long ago most people thought Japan had a ton of reserves.