FX accumulation by firms allows PBOC to step back

The People’s Bank (PBOC) further reduced its foreign exchange purchases to around $6bn in May, the lowest in almost a year. Given last month’s large trade surplus, this might suggest that capital inflows have finally reversed. A closer look reveals that the key shift has actually been a surge in foreign currency deposits in China’s banks. This makes sense: as expectations for the renminbi’s likely appreciation have diminished, it has become more attractive for firms to hold onto foreign revenues for longer. But this is not an outflow from China and certainly not a sign of capital flight. What’s more, companies are unlikely to want to accumulate foreign currency deposits indefinitely. As they step back, the PBOC will have to step up its foreign exchange purchases again if it wants to slow the renminbi’s rise.