Falling forex reserves trigger concerns of policy easing

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China's central bank said Friday that the country's foreign exchange reserves as of the end of the fourth quarter last year had fallen to 3.18 trillion U.S. dollars, down 20.6 billion U.S. dollars from the previous quarter.

The net quarterly decrease was a rare case in recent years for the country, which is currently the world's largest holder of foreign exchange reserves.

Foreign exchange reserves increased by 72.1 billion U.S. dollars in October, but decreased by 52.9 billion U.S. dollars and 39.76 billion U.S. dollars in November and December, respectively, according to data from the People's Bank of China (PBOC), the country's central bank.

Analysts say the drop in foreign exchange reserves in December is a strong indication of speculative capital flowing out of the country amid the sovereign debt crisis in Europe and economic turmoil in the United States.

The PBOC data released Friday also showed the country's yuan funds outstanding for foreign exchanges fell to 25.36 trillion yuan (4 trillion U.S. dollars) in December, down 100.3 billion yuan from November. The December data also marked the third monthly decline.

The monthly fall was dramatic compared to decreases of 24.9 billion yuan and 27.9 billion yuan in October and November, respectively.

"Falling forex reserves and yuan funds stemming from foreign exchanges are normal reflections of the current foreign exchange market impacted by the European debt crisis. They are in line with market expectations," said Ding Zhijie, dean of the School of Banking and Finance of the University of International Business and Economics.

The scale of the inflow of speculative overseas capital, or "hot money," can be measured simply by subtracting trade surplus and foreign direct investment (FDI) from newly-increased yuan funds.

The sharp decrease of yuan funds further suggested that foreign capital outflows were gaining traction, because China registered growth in both FDI and its trade surplus. Customs data showed that the trade surplus in December widened to 16.52 billion U.S. dollars from 14.53 billion U.S. dollars in November.

FDI data for December has not been released. In November China attracted 8.76 billion U.S. dollars in FDI.

Falling yuan funds also came at a time when expectations for appreciation of the Chinese currency, the yuan, weakened in December on concerns of a slowdown in the world's second largest economy. The country's GDP grew 9.1 percent in the third quarter, down from 9.7 percent in the first quarter and 9.5 percent in the second quarter last year.

In December, the yuan continued to depreciate against the U.S. dollar on spot markets due to concerns that faltering external demand would hurt growth in China.

Zhang Ming, an international finance expert with the Chinese Academy of Social Sciences, predicted that overseas short-term capital will continue to flow out of newly emerging economies in the first half of this year.

In the first half of last year, rising yuan funds were a problem for the nation's monetary authorities, complicating their task of introducing policies to steady economic growth and control inflation. By purchasing foreign currencies, the central bank releases an equivalent value of yuan funds into the domestic market, which leads to increased liquidity.

However, the continuous decrease of yuan funds, and especially the sharp decline registered in December, sparked speculation of further loosening of monetary policies as inflation eased to 4.1 percent last month, the slowest rise in 15 months.

To replenish liquidity in the country's banking system as inflation eased, the central bank on Dec. 5 lowered banks' reserve requirement ratio by 50 basis points for the first time in three years.