FXStreet (Mumbai) - China's reserves fell more than $87 billion in November, much higher than the $33 billion estimated, marking the third largest decline in reserves recorded by China. It is only slightly short of the $94 billion drop in reserves that the economy witnessed in August. Reserves had reached their zenith in June 2014 touching $3.993 trillion.



Back in October, when data on reserves had highlighted a decline in reserves for September, Singapore-based Zhou Hao, senior economist in Asia at Commerzbank had warned more fall was likely in the coming months. He had said, “As PBoC intervened into the forward market in the past month, the foreign reserves will likely plunge again when these forward contracts matures.”



How fall in major currencies against the dollar led the Chinese reserves to slide?



Major currencies weakened against the dollar in recent times. The euro has been falling steeply. It fell 4 per cent in November. China's euro holdings were hit in the process. The depreciation of the euro in itself accounted for a very sharp decline in the value of China's reserves. A third of the decline in China's reserve holding was due to the loss of euro’s strength. Apart from the euro, the Swiss franc, the Japanese yen and the sterling also fell when pitted against the dollar. The fall in currencies added up to weigh on China’s reserves.



Will inclusion of yuan in SDR impact China’s reserves?



On November 30th, the IMF decided to include the yuan in the SDR basket. The IMF had flagged their worry that the Chinese currency was too tightly controlled and that could prevent the yuan’s inclusion. China who was lobbying hard for this inclusion had then decided to devalue its currency. Following August’s devaluation the yuan had strengthened in September and October.



The currency however soon started falling and fell 1.25% in November. The investors are now apprehensive that post the inclusion Beijing will no longer intervene to defend the yuan and the currency will be allowed to slip with the objective of boosting the slowing economy. However, having said that, it must also be noted that China also has reasons why it should also control further weakening of the yuan. A weak yuan boosts exports but will hinder PBoC’s efforts to speed up recovery. Julian Evans-Pritchard, an economist with Capital Economics explained “depreciation would set back their efforts to encourage increased international use of the currency and could slow the process of economic rebalancing toward consumption.”



Also, being selected in the SDR will not automatically turn the wheel in favour of the yuan. No immediate substantial inflows of capital can be expected just because the currency got included in the SDR basket.



China’s trade balance and capital outflows



China’s trade data was released today. It showed November’s trade balance at $54.10 billion and revealed further weakening of exports. Exports declined worse-than-expected 6.8 per cent on year on year comparison, marking fifth straight month of decline. Imports on the other hand declined 8.7 per cent. Often when trade balances fail to translate into reserve increase, it results in capital outflows. This is what has happened in case of China. Though China has a merchandise surplus, it runs a deficit on services.