Question

Read the article on China’s Forex Reserve . In your opinion and from the article, why had China’s foreign reserve kept dropping? What would be the Chinese government’s motivation in lowering its foreign reserve at the time the article was published?

China Foreign-Exchange Reserves Keep Dropping; Reserves fall to lowest levels in nearly six years, testing central bank's resolve to stabilize the yuan Wei, Lingling . Wall Street Journal (Online); New York, N.Y. [New York, N.Y] 08 Jan 2017: n/a.

Abstract Since August 2015 when the central bank devalued the yuan by about 2%, the Chinese currency has weakened by more than 10% against the dollar and by 7% against a basket of currencies of China's major trading partners. Full Text BEIJING--China's foreign-exchange reserves fell to the lowest level in nearly six years last month, testing the central bank's resolve to control the yuan's descent to a pace it dictates.
The People's Bank of China said Saturday that the world's largest stockpile of foreign currency fell $41.08 billion in December to $3.011 trillion, the lowest level since March 2011. The decline was smaller than the previous month's drop of $69.06 billion and was largely in line with analysts' expectations.
The drop underscored the central bank's willingness to dip into reserves to buy up yuan and use capital controls and other tools to try to prop up the currency and restrain businesses and individuals rushing to send money offshore.
As the yuan keeps falling, more money is leaving China. A net $69.2 billion left the country in November, compared with a monthly outflow of about $50 billion since June, Goldman Sachs Group Inc. estimates.
How Chinese officials manage the yuan and the rise in capital outflows are major questions hanging over the world economy. Many investors say if the yuan declines too rapidly and capital flight from China intensifies, that could have a destabilizing effect on global markets.
Stocks and other risky assets plunged in 2015 after a surprise devaluation of the yuan, and markets across the globe sold off at the start of last year in part over concerns that China would devalue the currency again.
China's foreign-exchange regulator, an arm of the central bank, said efforts to stabilize the yuan are the main reason for the drop in the reserves. Other factors, it said, include the strengthening of the dollar against other currencies such as the euro, which dent the value of nondollar-denominated assets in the reserves in dollar terms.
The central bank is walking a tightrope trying to gradually deflate a currency that is widely seen as overvalued after years of steady appreciation. But just as betting on the yuan's rise seemed a sure bet for many years, the current strategy is reinforcing a belief among businesses and individuals that the yuan will keep falling, causing them to cash out and putting further downward pressure on the currency. To prevent the yuan from falling too fast, the central bank has burned through about $1 trillion of the reserves in the past 17 months.
The yuan dropped 4% in the fourth quarter, triggered by a surging dollar and accelerated capital outflows. To arrest the descent, in recent days the central bank has guided the yuan stronger and made the currency scarcer in Hong Kong, where it is freely traded, to confound market expectations and discourage wagers against the yuan.
For now, Beijing is sticking to the current way of managing the yuan and has ruled out letting it find its bottom quickly. At a high-level meeting last month, China's leadership, which has the final say in China's exchange-rate policy, named maintaining the yuan's stability as a key economic task for this year.
Meeting that goal, however, will likely be made harder by a new U.S. administration led by Donald Trump, which has signaled a tougher approach to trade with China, escalating tensions between the two. More interest-rate increases by the Federal Reserve would make U.S. assets more attractive, potentially luring more money out of emerging markets including China.
"The combination of a Trump presidency and a more hawkish Fed threatens China's exchange-rate policy," said Komal Sri-Kumar, president of Sri-Kumar Global Strategies, a Santa Monica, Calif.based macroeconomic consultant.
Given the tougher prospects and the dwindling stockpile of reserves, some prominent Chinese economists are urging policy makers to halt market intervention and let the yuan find its market value. Yu Yongding, an economist at government think tank Chinese Academy of Social Sciences and former adviser to the central bank, said China has a window from now until Mr. Trump's inauguration Jan. 20 to let the yuan weaken to an equilibrium level. Mr. Trump has threatened to label China a currency manipulator and slap blanket tariffs on Chinese imports.
Mr. Yu and others argue that the central bank could find itself in a vicious cycle: As it repeatedly draws on the reserves to prop up the yuan, doubts grow about its ability to keep the currency stable, which causes more money to leave the country, eroding the reserves further. Since August 2015 when the central bank devalued the yuan by about 2%, the Chinese currency has weakened by more than 10% against the dollar and by 7% against a basket of currencies of China's major trading partners. Economists at UBS Group AG estimate that the yuan is still modestly overvalued. A 10% depreciation of the yuan when measured against the currency basket could boost China's economic growth by 1% through increased net exports, the UBS economists estimate.
One question now is how much foreign currency China needs to have in reserves. When the stockpile peaked in mid-2014 at nearly $4 trillion, Chinese officials were concerned that the reserves had become too big to manage efficiently. Much of the reserves were in low-yielding U.S. government bonds.
The current $3 trillion still gives Beijing a large war chest to meet its obligations to foreign creditors. The reserves are twice the amount of China's foreign debt, six times its short-term external obligations and can cover more than 20 months of imports.
But the reserves appear to be less than abundant if gauged by another measure, the ratio of the currency reserves to M2, or the broad money supply, which includes savings deposits and moneymarket funds as well as cash. The International Monetary Fund, World Bank and others use the M2 ratio to gauge the sufficiency of countries' exchange reserves. The higher the ratio, the lower the likelihood of huge flight into other currencies.
Based on that measure, China should maintain between $2.13 trillion and $4.26 trillion of currency reserves to fend off any destructive capital outflow, according to economists at the Chinese Academy of Social Sciences.
"China has enough reserves to cover import bills and foreign debt payment but not for defending the currency over a long time," UBS China economist Wang Tao said

Answer 1

When Chinese Government tried to devalue its currency after years of its appreciation, this strategy was seen to have developed to increase the volume of its exports by making them more competitive in the international markets.

How this happens Let's say that initially 2 Yuan = 1 dollar

But after the currency got devalued, 4 Yuan= 1 dollar.

Therefore, using 1 dollar, now people could buy commodities worth 4 Yuans from China.

The devaluation of currency, also led to a wide belief among forex traders that, the Chinese government will further decrease its currency, leading to many people cashing-out, thereby increasing the supply of Yuan in the country. This has led to a more speedy devaluation of the Chinese currency. In order to, make the currency change/decrease its value over the period of time, the Chinese government started buying the Yuan by selling off foreign reserves, thereby decreasing the excess supply of Yuan in the market. This in my opinion led to decline in foreign reserves.

The motivation for the government as well was to have a steady pace of devaluation of its currency and to have complete control over its own currency and thus they chose the strategy of using foreign reserves to reach their goal.