Capital flight

China’s foreign exchange reserves have fallen below the psychological mark of $3 trillion for the first time in about six years


Photo: Bloomberg
Photo: Bloomberg

China’s foreign exchange reserves have fallen below the psychological mark of $3 trillion for the first time in about six years. It has lost about $1 trillion of reserves in defending its currency as capital flows out amid slowing growth and rising risk in the financial system. Policymakers in China face difficult choices.

For instance, if they defend the renminbi, China could keep losing its reserves. If they decide to save the reserves, the renminbi will fall, which could accelerate the capital flight, making the depreciation self-fulfilling. A sharp fall in the value of renminbi will increase the debt burden of Chinese companies that have borrowed in foreign currency and could potentially lead to financial instability. Any attempt to stimulate growth at this stage could lead to further accumulation of debt, while a continued slowdown in the economy is unlikely to stop capital outflows despite controls.

Clearly, the situation in China once again underscores the fact that there is no substitute for prudent macroeconomic management.

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