China — the world’s largest holder of foreign exchange reserves (forex reserves) — will likely need to impose capital controls as its forex stockpile will not be sufficient to defend its currency, the yuan, Societe Generale (SocGen) says, Bloomberg reports.
According to SocGen’s Jason Daw, if 65 million Chinese residents — approximately 5 percent of its population — each withdrew the maximum allowed $50,000 this would erase around $3.3 trillion of its currency reserves.
Based on the International Monetary Fund’s (IMF) methodology, China needs a currency stockpile of at least $2.8 trillion in order to manage with a balance-of-payments crisis, SocGen estimates.
“Just because you have the world’s biggest foreign-exchange reserves, the domestic monetary implications of running down your reserves at a rapid pace shouldn’t be underestimated,” says Kit Juckes, a strategist at Societe Generale, told Bloomberg.
“They have a clear choice: tightening the capital account or allowing the currency to depreciate more quickly,” Juckes said.
Chinese authorities have been trying to counteract record capital outflows and prop up its currency, while opening up its capital account and maintaining low borrowing costs in an effort to revive economic growth.
Bloomberg, however, highlights that such a balancing act China is trying to achieve challenges Nobel-winning economist Robert Mundell’s “impossible trinity” principle, that stipulates that a country cannot maintain independent monetary policy, a fixed exchange rate, in addition to free capital borders all at the same time.
SocGen believes that the Chinese yuan could drop as much as 12 percent this year to 7.5, if capital outflows intensify.
The bank estimates that China saw roughly $657 billion in capital flight in the six quarters through September and advises its clients to stay away from Chinese assets for now.