A desire on the part of Chinese households to diversify their investments may in part be behind the recent declines in China's foreign exchange reserves according to an economics professor.

The People's Bank of China (PBOC) - the nation's central bank - on Wednesday said currency reserves fell $43.3 billion in September to $3.51 trillion representing the fifth consecutive monthly drop. However the decrease was far less than the record $93.9 billion plunge in August.

Wei Xiong, a professor of economics at Princeton University in Princeton, New Jersey, said many factors may have contributed to the declining reserves including concerns from foreign investors about the Chinese economy.

"Another important factor is the increasingly strong motive for domestic Chinese households to diversify their investment portfolios. Due to the stringent capital controls in China, most households have kept their savings inside China, mostly parked in bank deposit, stocks, and housing. Bank deposit pays very low yield; Chinese stocks have been highly volatile this year; there is also growing concern about whether the high housing valuation across China is sustainable. These forces all motivate Chinese households to invest a fraction of their savings abroad," Xiong wrote in an email.

Xiong added that while China has not fully lifted capital controls, it has gradually relaxed the controls through various channels such as allowing each family to exchange 50,000 US dollars each year, and the opening of the direct shuttle between Shanghai and Hong Kong stock exchanges for investors of each exchange to purchase stocks on the other exchange.

"The declining foreign reserve reflects some domestic Chinese households taking advantage of the relaxed capital controls. China is likely to further relax its capital controls in pushing for the internationalization of RMB. Consequently, its foreign reserve will become more volatile with the likely inflow and outflow of investment capital by both domestic households and foreign investors across its border," he added.

"Even though the $43.3 billion fall in reserves seems large, it is less than half of the $93.9 billion fall in the previous month, indicating that the PBOC has been intervening less to prevent the yuan value from falling too far and too fast. More importantly, the discrepancy between the offshore and onshore yuan rate, which indicates how much the global market, thinks the yuan is overvalued, has disappeared over the past month. This signals that the market has gained confidence in the current yuan value, reflecting diminished concern about an accelerated slowdown in the Chinese economy," said Tailan Chi, a professor at the University of Kansas School of Business In Lawrence, Kansas, in an email.

Recognizing that China's economy was slowing more than anticipated, the PBOC has initiated a series of moves to increase liquidity in the economy including the easing of reserve requirements for banks. How will the declining reserves affect the PBOC's attempts to ease credit in the wake of the slowdown?

"The question is whether the PBOC sees an accelerated slowdown and whether the previous monetary easing is expanding lending sufficiently. I think that the PBOC is cautious about excessive credit expansion that can create round of growth in asset bubbles," Chi said.

paulwelitzkin@chinadailyusa.com