China's reserves of foreign currencies has surpassed $1 trillion for the first time. The deposits give the country greater freedom to allow outward capital flows.
Foreign currency deposits grew largely as a result of an increase in demand for China's goods throughout the pandemic. Because the country came out of the pandemic earlier than others also boosted foreign investments, which resulted in overseas participants buying more local currencies, stocks and bonds.
According to official data, bank deposits of foreign currencies grew by more than $260 billion from January to May this year. These forced regulators to ease capital controls and change the country's foreign exchange market to ensure the yuan remained stable. The yuan is currently trading at near five-year highs against several of its comparative currencies.
"Strong capital inflows offer a good window for China to carry out capital-account reforms and relax two-way capital flows. I expect further relaxation of capital outflows via investment schemes," analysts at Deutsche Bank AG in Hong Kong said.
The People's Bank of China said commercial lenders now had a record $1.38 trillion in foreign exchange - most of which are held in deposits. Lenders used the money to offer loans to overseas companies. As a result of banks buying local currencies, dollar borrowing costs in China are lower than in the U.S.
The bank said overseas participants bought around $154 billion in onshore bonds over the past year. Meanwhile, local exports rose to record highs as factories returned to full operation while the rest of the world was still under lockdown.
The PBOC said it was taking steps to reduce U.S. dollar liquidity. This includes increasing the quota for investors to buy overseas assets.
"Some may see the foreign-exchange liquidity as a feather in China's cap, and some may worry that the surge is flighty. It's fine when the flows are coming in, but a big problem for financial stability when they try to go the other way," analysts at Oxford University's China Center said.
