China’s Net Foreign Exchange Falls Sharply

People hold banners and chant slogans during a protest at the entrance to a branch of China's central bank in Zhengzhou in central China's Henan Province, on July 10, 2022, when four rural banks in the Henan Province stopped allowing customers to withdraw cash since April 2022. Yang/AP Photo

News Analysis

China’s foreign exchange reserves haven’t grown in eight years, while its foreign debt has increased dramatically. The country is on the eve of a financial meltdown as a result of its real estate bubble and massive local debts.

Together with rapidly declining exports to developed countries, all these problems will lead to a further deterioration of the foreign exchange reserves.

One economist believes that the sharp decline in foreign exchange reserves is pushing China toward a national credit crisis.

Data from the State Administration of Foreign Exchange show that China’s foreign exchange reserves stood at $3.1 trillion at the end of September. At the same time, China is saddled with a huge foreign debt. At the end of June, China’s foreign debt stood at $2.4 trillion. In other words, China’s net foreign exchange reserves were just over $680 billion.

At the end of December 2015, the size of China’s foreign exchange reserves reached $3.3 trillion, while the balance of its foreign debt was $1.4 trillion. Over the past eight years, China’s foreign exchange reserves have not grown, while its foreign debt has surged by $1.02 trillion, an increase of more than 70 percent.

Foreign Reserves Fall Despite Trade Surplus

The trade surplus is one of the most important factors affecting foreign exchange reserves. China’s economy is export-oriented, and Beijing claims to have had trade surpluses all these years.

Official figures show that in the first half of this year, the trade surplus was more than $400 billion, and last year’s trade surplus was nearly $700 billion, a record high. If these numbers are real, why haven’t China’s foreign exchange reserves increased?

U.S.-based economist Davy Jun Huang told The Epoch Times that it’s because the countries to which China exports its products are mostly using Renminbi settlement.

China’s exports now mainly go to Southeast Asian countries, the “Belt and Road” countries, and Russia. All of these countries mainly use Renminbi settlement instead of foreign exchange settlement, so it isn’t very helpful for China’s foreign exchange reserves, Mr. Huang said.

“If exports to Europe and the United States don’t improve, it will have a very negative effect on China’s foreign exchange reserves in the long run,” he added.

The United States and Europe have sought to “de-risk” their trade with China as the Chinese Communist Party (CCP) poses a growing threat to the world, and their trade volume with China continues to decline.

Take U.S. imports as an example. In the 12-month period that ended in July, the share of goods imported from China fell to its lowest level in 17 years.

“At the same time, China’s economy is facing two major crises—the real estate crisis and the local government debt crisis. When China’s economy is in crisis, investors will stay away and even pull their money out of China. This will also have a very negative impact on China’s foreign exchange reserves,” Mr. Huang said.

Consequence of Foreign Exchange Reserve Crisis

If China encounters a foreign exchange reserve crisis, there are three major effects, according to Mr. Huang.

First, it will be very difficult for China to import goods, technology, and services. This is because many of the core technologies, core products, and core services that China imports come from developed countries in Europe and the United States. These countries won’t accept Chinese currency but must settle in U.S. dollars or euros.

Second, China’s development over the past two to three decades is inseparable from the injection of foreign capital into China and the development of China’s manufacturing industry.

In the event of a crisis in foreign exchange reserves, foreign businesses and investors might fear that their profits and investments won’t be exchangeable into dollars or other foreign currencies to be taken out of China. Such a situation could trigger a currency run, intensifying the decline in China’s foreign exchange reserves and making new foreign investors hesitant to enter.

Third, in terms of international credit, China would be caught in a national credit problem, which would make it even more difficult for China to borrow U.S. dollars and foreign currencies in the international market. Overall, the shortage of foreign exchange reserves will worsen, creating a vicious cycle.

Shortage of Currency Reserves Worries Xi

On Oct. 24, Chinese leader Xi Jinping, along with Vice Premier He Lifeng and other officials, visited the State Administration of Foreign Exchange and the central bank, the People’s Bank of China.

Mr. Xi had never visited the central bank in his 11 years in power. In fact, since the inception of communist China, none of the CCP’s top leaders, before Mr. Xi, had ever conducted an inspection at the central bank. It’s customarily the premier or the vice premier responsible for economic matters who handles such inspections.

The reason for Mr. Xi’s visit to the foreign exchange regulator was to gain a better insight into China’s $3 trillion currency reserves, according to a person with insider information.

2 Major Economic Crises

The real estate bubble, coupled with mounting local government debts throughout China, is exacerbating the nation’s economic downturn. This has initiated a negative feedback loop concerning China’s foreign exchange reserves, which are expected to decline even further because of the deteriorating economy.

China’s two real estate giants, Evergrande and Country Garden, are both in debt defaults, and the effect is spreading to other industries.

Evergrande’s total liabilities are 2.39 trillion yuan (about $326 billion), and the total liabilities of Country Garden are 1.43 trillion yuan (about $195 billion).

Meanwhile, China’s local government debt is yet another black hole.

The debt balance of local governments in China amounted to 37.8 trillion yuan (about $5.2 trillion) as of the end of June, official data from the Ministry of Finance show. And that’s just the visible debt.

Using the “local government financing platforms” for funding, the expenditures tied to infrastructure and various services are not listed on the financial reports of the local government.

This hidden debt is so large that even the Chinese premier doesn’t know the exact numbers in each province. In August, the CCP’s State Council sent a working group to 10 provinces to audit their accounting books.

According to an assessment by Goldman Sachs, the total debt of China’s local governments, including hidden debt, totals 94 trillion yuan (about $13 trillion).

Because of excessive local government debt, Guizhou, Shandong, Yunnan, and several other provinces have reported difficulties since the beginning of the year in repaying bonds as they mature.

A meltdown of China’s real estate sector will further aggravate the debt situation for local governments. In 2021, the real estate sector contributed nearly 50 percent of local fiscal revenue in China.

Ning Xin contributed to this report.