The Case For “Global Quantitative Tightening”

In January 2016, global foreign reserves (FX) continued their decline after an absolute peak in June 2014, declining significantly in distressed emerging countries and some notable oil-producing economies (see Figure 1).

Figure 1.

China and Saudi Arabia, the leading owners of foreign reserves outside the OECD circle, both experienced an outflow greater than 5% of their outstanding reserves in less than 6 months (see Figure 2). A common factor explains these drawdowns: both the countries are struggling to defend their currency peg to the Dollar. The pressures on the exchange rates can be traced back to three intertwined drivers: the (still to come) interest rate hike cycle in the US, the low oil price and the China slow growth. While the “US rate hike tantrum” can be considered as a symmetrical shock for all the worlds currency different from the Dollar, the other factors have hit the distressed countries in differentiated ways. 

From the Chinese side, the worsening growth’s prospects and strong capital outflows are forcing the People’s Bank of China (PBOC) to employ its FX reserves with the aim to manage a controlled, but unavoidable, devaluation. Meanwhile, the persistent slump oil price (that depends a lot from China’s slowdown) have decimated the revenues of the Saudis. Since these money flows count for over 80% of the State budget, the government is now tapping the debt market at the astronomical pace of 16% of GDP at year to compensate for the loss. This dramatic reversal in the health of public finances obviously put pressure on the fixed peg with the dollar. 

Figure 2.

Indeed, as it emerges from the comparative analysis of Figures 1,2, both the declines for China and Saudi Arabia took off and reinforced during the prolonged crash of the oil price. The same phenomenon can be appreciated on a global scale (Figure 3): world FX reserves peaked and declined in sync with the oil price. Net of “value effects” that depend from the changing composition of the reserves, falling oil revenues and GDP slowdown in major exporting countries remain significant explaining factors.