Beijing swells dollar reserves through stealth

China has resorted to stealth intervention in the
currency markets to amass US dollars, using indirect means to hold down
the yuan and ease the pain for its struggling exporters as the global
slowdown engulfs the economy.

A study by HSBC’s
currency team in Asia has concluded that China’s central bank is in
effect forcing commercial banks to build up large dollar reserves,
using them as arms-length proxies in a renewed campaign of exchange
rate intervention.

Beijing has raised the reserve requirement for banks
five times since March, quickening the pace with two half-point rises
in late June.

This is having major spill-over
effects into the currency markets because banks in China have been
required over the last year to hold extra reserves in dollars rather
than yuan. The latest moves have lifted the mandatory deposit from 15pc
to 17.5pc of total lending since March.

“China has
used the pretext of reserve requirement hikes to help slow yuan
appreciation. We estimate that the PBOC [central bank] intervened by
about $49.6bn in June,” said Daniel Hui, the bank’s Asia strategist.

Beijing
has also slashed the amount of foreign debt banks operating in China
can hold. The effect is to oblige the banks to become net buyers of
dollars, halting the flow of foreign “hot money”.

Given the sheer scale of China’s foreign reserves -
now $1,800bn (£970bn) - any shift in its exchange policy now ripples
around the globe. The covert buying may help to explain at least part
of the explosive dollar rebound over recent weeks.

There
is little doubt that the key driver behind the wild currency ructions
this summer has been the blizzard of dire data from Britain, Europe,
Japan and Australasia. The mounting danger of a full-fledged recession
across the club of rich OECD nations appears to have caught the markets
off guard.

The closely watched Dollar Index reached
an all-time low in March. It crept up gradually in the early summer
before smashing through resistance in July.

The
world’s currency system is swivelling on its axis. Central banks in
Asia and Europe have stopped raising rates, and some have begun to cut
aggressively. The Federal Reserve is no longer nakedly exposed. Indeed,
investors are already starting to look ahead to the next round of Fed
tightening.

The 18pc slide in oil prices from a
peak of $147 a barrel in July has added juice to the dollar rally.
Russia and the Middle East petro-powers tend to recycle a high
proportion of their vast earnings from oil into the eurozone, either by
purchasing European bonds or expensive imports.

A
Bundesbank study found 40 cents of every dollar spent by eurozone
countries on oil imports comes back again one way or another. The
figure for the US is just 10 cents. This trade bias has given oil a new
character as a sort of anti-dollar driving the currency markets.

Even
so, the China effect is a key ingredient in the dollar comeback.
Beijing’s Politburo is clearly disturbed by the sudden downward turn in
the economy as export markets freeze, and surging wage inflation in the
country’s manufacturing hubs eats away at profit margins.

“They are now more worried about growth than
overheating, and you are seeing that play out in the currency markets.
There has been a remarkable change of view,” said Simon Derrick,
exchange rate chief at the Bank of New York Mellon.

China’s
PMI purchasing managers index fell below 50 for the first time in July,
signalling an outright contraction in manufacturing output. Hong Kong’s
economy contracted 1.4pc in the second quarter. The Politburo has
rushed through special rebates for textile producers now caught in a
ferocious downturn.

Much of the clothing, footwear and furniture industry has been hit, leading to mass plant closures in the Pearl River Delta.

“During
the first half of this year, about 67,000 small and medium-sized
companies went bankrupt throughout China, leaving more than 20m people
out of work,” said the National Development and Reform Commission.
“Bankruptcies of textile and spinning companies have numbered more than
10,000. Two thirds are on the brink of bankruptcy.”

Last week’s rebound on the Shanghai stock market stalled on fading
hopes of a fiscal stimulus package. “It is unrealistic to expect the
government to rescue the market,” said Li Ka-shing, chairman of
Hutchison. “Speculators should be very cautious now. The worst is not
over in the global credit crisis.”

Lehman Brothers
warns of a risk that a housing slump and the 55pc equity crash since
October could combine with a global downturn to set off a “vicious
cycle”. House prices have already fallen 18pc in Guangzhou and 9pc in
Beijing. Prices are now falling in cities that make up over half
China’s population.