According to the State Administration of Foreign Exchange, by the end of January, China's foreign exchange (forex) reserves had hit $3.18 trillion, up by $56.8 billion, or 1.82 percent, over the end of 2022, the fourth monthly hike in a row.

Last year, China withstood severe tests from renminbi (RMB) exchange rate fluctuations and from the international foreign trade market, which have strengthened its ability to maintain steady economic growth this year.

In 2022, jumbo interest rate increases by the U.S. Federal Reserve and COVID-induced downward pressures on China's economy caused the RMB to depreciate by 9 percent against the U.S. dollar. Particularly, in early November, when the exchange rate slid from a peak of 6.3 yuan to the rock bottom of 7.3 yuan against the dollar, there were widespread concerns about the stability of the Chinese economy. Fortunately, the exchange rate soon bounced back to below 7 yuan to the dollar, soothing market sentiment.

Steady growth of forex reserves makes it possible for China to bring currency-related risks under control more easily. When the exchange rate weakened to more than 7 yuan against the dollar, China's forex authorities managed to stabilize expectations on the yuan's exchange rate through measures such as raising the risk reserve requirement on forward forex sales, and preventing radical ups and downs of RMB exchange rates.

Thanks to adequate forex reserves, the RMB exchange rate achieved greater flexibility in 2022.

China's cross-border capital flows for the whole year reached an equilibrium. Despite complex internal and external environments that continue to change, the fluctuation of indexes indicating expectations on the RMB exchange rate in the forward and futures markets was still controllable.

Surplus in goods trade and foreign direct investment (FDI) buoyed China's forex reserves, which in turn stabilized cross-border capital flows. In 2022, net capital inflows from goods trade hit a new high, up 45 percent over 2021, while FDI was valued at $189.1 billion, up 8 percent year on year.

Net inflows of FDI reveal China's competitive edges in the global industrial and supply chains. Meanwhile, China's foreign exchange market has always tried to adapt itself to external changes. An improved RMB exchange rate regime and higher flexibility of the yuan's exchange rate may help to release external pressures. All this has emboldened China when it needs to turn to its forex reserves toolkit.

Other factors such as the falling U.S. dollar index (USDX), rising prices of financial assets around the globe as well as currency conversion and asset price changes have all helped push up China's forex reserves. However, currently, the driving force from the USDX is on the retreat. Even if the falling USDX does help ramp up China's forex reserves, its role is quite limited.

Inflation in Western economies has recently eased, which may well lead to a slowdown of monetary tightening and a diminishing spillover effect. Despite the many external uncertainties in 2023, China's domestic economy is expected to rebound on the whole, thus attracting more FDI. This way, its forex reserves will again help stabilize cross-border fund flows. Continuous efforts to make cross-border trade and financing more convenient will also encourage capital flows. The Chinese economy on the whole remains resilient and vibrant, and is thus able to provide a solid foundation for a stable forex market. 

Copyedited by G.P. Wilson

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