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Officially reported reserves at year-end 2008 were $1.9 trillion, a mere $40 billion increase compared to the figure at the end of September. In contrast, the average quarterly increase in reserves in the first three quarters of the year was $126 billion. Taking into account the trade surplus in the fourth quarter ($114 billion) and foreign direct investment inflows, and then adjusting for some of the other factors mentioned above, many analysts concluded that there were large outflows of “hot money” (money that chases higher interest rates) in the fourth quarter, “big, scary FX outflows,” according to Standard Charter’s report of January 14.
But the recent analyses and news reports appear to overlook the use of foreign exchange to clean up the balance sheet of the Agricultural Bank of China (ABC). The ABC is the last unreformed, large state-owned bank. It acknowledged that its nonperforming loans at the end of 2007 were RMB 818 billion, almost a quarter of its loan portfolio. But by the end of November 2008 ABC had shed RM 800 billion in nonperforming loans and its nonperforming loan ratio was down to 4 percent. If official reserves were used to clean up ABC’s balance sheet, then it would be the case that official intervention in the foreign exchange market was much greater than suggested by the modest increase in reserves. And the true magnitude of foreign exchange reserves expanded substantially more rapidly than the reported $40 billion increase in official reserves in the fourth quarter of last year. Thus the conclusion of Brad Setser that “Chinese reserve growth has essentially stopped” may not be warranted and the Wall Street Journal’s assertion that China is now faced with the challenge of restoring market confidence in the renminbi may be a vast exaggeration. The details, for those that are interested, follow.
The Chinese language People’s Bank of China (PBOC) reports of January 13, 2009, and December 15, 2008, (available at http://www.pbc.gov.cn) on lending by Chinese banks in November and December used the phrase “an kebi koujing,” i.e., “according to comparable scope,” when they give the percentage increase in RMB lending compared to the same month in the prior year. This phrase did not appear in any of the earlier monthly PBOC reports in 2008. PBOC has used this phrase in the past when there was a discontinuity in the time series data on loans outstanding. Specifically it was used a number of times in the late 1990s and again a few years ago at the time of the restructuring and listing of three large state-owned banks. On these occasions there has been a significant reduction in the volume of loans outstanding from the financial system due to a centrally financed write-off of nonperforming loans. Thus the numbers on loans outstanding before and after these write-offs are not comparable.
Specifically, the January 13 report said that RMB loans outstanding at year-end 2008 were RMB 30.35 trillion, up 18.76 percent in “comparable terms.” That implies that loans outstanding at the end of 2007 were RMB 25.56 trillion. But prior reports placed that number at RMB 26.17 trillion. I believe that means that write-offs of loans in 2008 must have been about RMB 610 billion. An analysis of the December 15 report implies a somewhat higher number, around RMB 720 billion. These numbers are roughly consistent with the reported RMB 800 billion reduction in nonperforming loans of the balance sheet of the ABC by November 2008 compared with year-end 2007 on the assumption that a portion of the write-offs was financed from ABC loan loss reserves.
This large amount of write-offs is almost certainly in connection with the restructuring of the Agricultural Bank of China. The bank was converted in the fourth quarter last year to a shareholding ownership structure, in advance of a hoped-for initial public offering. In November the authorities reported that Central Huijin had injected $19 billion dollars (equivalent to RMB 130 billion) to bolster the capital of the bank. This is the same model followed earlier by the Industrial and Commercial Bank of China, the Bank of China, and the China Construction Bank. At the time those banks were restructured, there was a centrally financed (via Central Huijin) write-off of nonperforming loans and an injection of capital to clean up the balance sheet of these banks prior to listing. Foreign exchange funds were used in these transactions, meaning bank holdings of foreign exchange went up and official holdings in foreign exchange reserves went down.
In the past clean ups of the balance sheets of state-owned banks, the forex used was not transferred from official reserves to Central Huijin (which is now part of the China Investment Corporation, China’s sovereign wealth fund) until just before the clean up was undertaken. I believe this practice has not changed and that centrally funded write-offs of nonperforming loans of the Agricultural Bank of China could account for $90 billion to $100 billion of the “unexplained capital outflow” in the fourth quarter of 2008. Thus the combined centrally financed injection of capital, which has been reported, and nonperforming loan write offs, which have not been reported, for the Agricultural Bank of China could have reduced officially reported official foreign exchange holdings by $110 billion to $120 billion.
Thus, I believe the conclusion that Chinese reserve growth has stopped may be incorrect. Properly accounted, it appears that official intervention in the foreign exchange market has not waned and reserve build-up has not stopped. The increase in reported reserves in Q4 is probably significantly understated (as it has been at several times in the past) because of the transfer of forex from official reserves to Central Huijin for bank recapitalization, i.e., actual exchange market intervention and reserve build-up in Q4 was $110 billion to $120 billion more than implied by the official data. And the “unexplained” outflows of “hot money” in the fourth quarter of last year, estimated at $164 billion and $150 billion by Brad Setser and Standard Charter, respectively, may be far too high.
by Nicholas Lardy for the REALTIME ECONOMIC ISSUES WATCH blog on the website for the Peterson Institute of International Economics.
But the recent analyses and news reports appear to overlook the use of foreign exchange to clean up the balance sheet of the Agricultural Bank of China (ABC). The ABC is the last unreformed, large state-owned bank. It acknowledged that its nonperforming loans at the end of 2007 were RMB 818 billion, almost a quarter of its loan portfolio. But by the end of November 2008 ABC had shed RM 800 billion in nonperforming loans and its nonperforming loan ratio was down to 4 percent. If official reserves were used to clean up ABC’s balance sheet, then it would be the case that official intervention in the foreign exchange market was much greater than suggested by the modest increase in reserves. And the true magnitude of foreign exchange reserves expanded substantially more rapidly than the reported $40 billion increase in official reserves in the fourth quarter of last year. Thus the conclusion of Brad Setser that “Chinese reserve growth has essentially stopped” may not be warranted and the Wall Street Journal’s assertion that China is now faced with the challenge of restoring market confidence in the renminbi may be a vast exaggeration. The details, for those that are interested, follow.
The Chinese language People’s Bank of China (PBOC) reports of January 13, 2009, and December 15, 2008, (available at http://www.pbc.gov.cn) on lending by Chinese banks in November and December used the phrase “an kebi koujing,” i.e., “according to comparable scope,” when they give the percentage increase in RMB lending compared to the same month in the prior year. This phrase did not appear in any of the earlier monthly PBOC reports in 2008. PBOC has used this phrase in the past when there was a discontinuity in the time series data on loans outstanding. Specifically it was used a number of times in the late 1990s and again a few years ago at the time of the restructuring and listing of three large state-owned banks. On these occasions there has been a significant reduction in the volume of loans outstanding from the financial system due to a centrally financed write-off of nonperforming loans. Thus the numbers on loans outstanding before and after these write-offs are not comparable.
Specifically, the January 13 report said that RMB loans outstanding at year-end 2008 were RMB 30.35 trillion, up 18.76 percent in “comparable terms.” That implies that loans outstanding at the end of 2007 were RMB 25.56 trillion. But prior reports placed that number at RMB 26.17 trillion. I believe that means that write-offs of loans in 2008 must have been about RMB 610 billion. An analysis of the December 15 report implies a somewhat higher number, around RMB 720 billion. These numbers are roughly consistent with the reported RMB 800 billion reduction in nonperforming loans of the balance sheet of the ABC by November 2008 compared with year-end 2007 on the assumption that a portion of the write-offs was financed from ABC loan loss reserves.
This large amount of write-offs is almost certainly in connection with the restructuring of the Agricultural Bank of China. The bank was converted in the fourth quarter last year to a shareholding ownership structure, in advance of a hoped-for initial public offering. In November the authorities reported that Central Huijin had injected $19 billion dollars (equivalent to RMB 130 billion) to bolster the capital of the bank. This is the same model followed earlier by the Industrial and Commercial Bank of China, the Bank of China, and the China Construction Bank. At the time those banks were restructured, there was a centrally financed (via Central Huijin) write-off of nonperforming loans and an injection of capital to clean up the balance sheet of these banks prior to listing. Foreign exchange funds were used in these transactions, meaning bank holdings of foreign exchange went up and official holdings in foreign exchange reserves went down.
In the past clean ups of the balance sheets of state-owned banks, the forex used was not transferred from official reserves to Central Huijin (which is now part of the China Investment Corporation, China’s sovereign wealth fund) until just before the clean up was undertaken. I believe this practice has not changed and that centrally funded write-offs of nonperforming loans of the Agricultural Bank of China could account for $90 billion to $100 billion of the “unexplained capital outflow” in the fourth quarter of 2008. Thus the combined centrally financed injection of capital, which has been reported, and nonperforming loan write offs, which have not been reported, for the Agricultural Bank of China could have reduced officially reported official foreign exchange holdings by $110 billion to $120 billion.
Thus, I believe the conclusion that Chinese reserve growth has stopped may be incorrect. Properly accounted, it appears that official intervention in the foreign exchange market has not waned and reserve build-up has not stopped. The increase in reported reserves in Q4 is probably significantly understated (as it has been at several times in the past) because of the transfer of forex from official reserves to Central Huijin for bank recapitalization, i.e., actual exchange market intervention and reserve build-up in Q4 was $110 billion to $120 billion more than implied by the official data. And the “unexplained” outflows of “hot money” in the fourth quarter of last year, estimated at $164 billion and $150 billion by Brad Setser and Standard Charter, respectively, may be far too high.
by Nicholas Lardy for the REALTIME ECONOMIC ISSUES WATCH blog on the website for the Peterson Institute of International Economics.