Emerging markets’ FX reserves burn apace in race to defend currencies


SINGAPORE/NEW YORK — Emerging markets (EM) have been consuming their stockpiles of foreign exchange reserves this year at a faster pace than in previous bouts of currency weakness as central banks fight to defend their currencies against the mighty US dollar.

China, which holds the world’s largest total forex reserves in excess of $3 trillion, drew down $195 billion from January to August this year, according to Chinese central bank data.

This was more than six times the $30 billion it depleted over the same period in 2018, during the US Federal Reserve’s previous tightening cycle. During another strong dollar phase in 2014, China’s forex reserves fell by $61 billion from March to October.

“A lot of central banks are facing that extremely difficult choice right now, when their currencies are depreciating against the dollar,” said Ana Jelenkovic, sovereign strategist of the emerging markets group at Marathon Asset Management, referring to currency reserves.

“Do they let that be the buffer, do they let that absorb the shock? Or do you use some of your assets, reserve buffers, if you think this is just sort of a temporary shock?”

India’s forex reserves had fallen by $71 billion by August this year, while Brazil lost $29 billion by September.

In contrast, during 2014’s-dollar strength, both countries had recorded an increase in their reserves in the eight months to October.

The rupee is down almost 10% against the dollar this year. While Brazil’s reserves have also fallen, it has seen its real rise about 5%, supported by one of the highest reserves to short-term external debt ratios among emerging markets.

To be sure, the stark drawdowns in reserves this year -— which are calculated in US dollars -— could partially be attributed to valuation effects. The surging US dollar has knocked many currencies to multi-year lows, with the euro down 13% year to date, sterling down 16% and the yen more than 20% lower.

“(Central banks) also invest their reserves in other non-dollar currencies… so you have that kind of translation impact,” said Yan Wang, chief emerging markets and China strategist at Alpine Macro. “That’s at least a part of the reason why reserves are falling.”

UBS calculated that on a six-month moving average, forex reserves across emerging markets fell by $21.2 billion in September on an FX valuation-adjusted basis. The unadjusted drop is a bigger $85.8 billion.

OUT OF THE BOXThe pace at which forex reserves have been used up has prompted some policy makers to use creative methods in the face of a hawkish Federal Reserve and towering dollar.

China’s state banks sold a high volume of dollars to buy yuan, but used swaps to procure dollars, banking sources told Reuters. Both onshore and offshore yuan have weakened around 12% year to date.

Similarly, to conserve reserves, the Reserve Bank of India (RBI) has been intervening in both the spot and forward markets through state-run banks.

Policy makers in countries from the Czech Republic to Chile have been stepping in to shore up currencies through interventions, in addition to rate hikes this year.

Nonetheless, analysts say there is no need to sound the alarm over the declines in reserves.

“This is precisely what reserves are for. They’re definitely going to replenish reserves when it comes to better times,” said Galvin Chia, an emerging markets strategist at NatWest Markets.

The concern, however, would be a more gradual recovery in these currencies once the dollar peaks, as central banks soak up incoming flows as they prioritize replenishing their reserves.

“That means that even if the dollar cycle turns… a lot of EM currencies may not see tremendous upside because the central banks will use that opportunity to rebuild their reserves,” said Manik Narain, head of emerging markets strategy at UBS in London. — Reuters