The People’s Bank of China yesterday reported that China’s foreign reserves fell to the lowest level in more than three years in January. The foreign reserves plunged by $99.5 billion in January to $3.23 trillion after plunging by a record $107.9 billion in December. The decline continues largely due to the central bank’s intervention in the foreign exchange market to determine the yuan. The PBoC’s attempt to set the guide the yuan lower had caused the currency to hit five year low in January, leaving investors unsure about the health of the Chinese economy and leading them to move capital out of China and park it at overseas market. Agreed, China’s foreign reserves is the largest in the world. However, if the central bank has to draw its reserves to constantly support the falling yuan, the reserves might soon get depleted. Back in August, the PBoC in a bid to get the yuan included in the IMF’s SDR basket had wanted to give an impresson that it is willing to give more play to the market forces in determing the currency value. It had devalued the yuan in the process. However, the efforts led to to investors fleeing the system resulting in huge capital outflow. This pushed the cenral bank to utilize its resources to support the yuan. Once again last month, weak fundamentals had sparked renewed worries of a deeper than expected slowdown in China. Yuan was guided lower once again. Investors panicked and there was a large sell off of stocks and commodities. Economists are therefore now questioning to what extent the central bank can continue its policy of intervention. This repeated drawing of reserves raises doubt on whether the central bank can manage to bring about stability in its currency. This causes further outflow of capital and in turn the central bank has to dig in deeper into its reserves to support the falling yuan. An official at China’s central bank admitted “It likely will be a long battle”. He also noted there the central bank currently faces the challenge of keeping the currency stable and at the same time managing investors’ expectations given the slowdown in the economy. He however added that “But China still has sufficient reserves to withstand any external shocks.” What do investors fear? A rapid devaluation of their currency is mostly likely to destabilize the Chinese economy. Given that several Chinese businesses hold debt in dollars these companies stand a heightened chance to fail as it will get difficult to manage those debts with a weakened yuan. China therefore has stepped up efforts to devalue the yuan in an orderly manner, that however is yet to prove beneficial. Speculators think the currency will fall further. Such speculations have led investors to yank capital further from the Chinese system. China has been selling dollars to buy yuan. The central bank has also curbed currency speculation and directed offshore banks to hold their reserves of yuan. For more information, read our latest forex news.