China cuts rates as forex reserves shrink

China cut interest rates on Monday. Bloomberg reports:

China cut interest rates for the fifth time in three months after trade growth collapsed because of recessions in the U.S., Europe and Japan.

The one-year lending rate will drop by 0.27 percentage point to 5.31 percent and the deposit rate by the same amount to 2.25 percent from tomorrow, the People’s Bank of China said on its Web site. The central bank also reduced the proportion of deposits lenders must set aside as reserves by 0.5 percentage point.

However, the cut wasn't as big as expected.

“The surprise is how small the move is,” said Mark Williams, an economist with Capital Economics in London. “There’s been a sudden very rapid deterioration in all China’s economic data over the last 8 to 12 weeks.”

Interestingly enough, China also indicated on Monday that its foreign exchange reserves have fallen. From Reuters:

China's foreign exchange reserves, the world's largest stockpile, shrank in October to less than $1.89 trillion, their first monthly fall since December 2003, a source familiar with the situation said on Monday.

The reserves stood at $1.906 trillion at the end of September, the last date for which official figures have been reported, meaning they fell by at least $16 billion during October.

The source, who wished not to be identified, declined to say whether the reserves continued to fall in November. The only other month since the start of 2000 during which the reserves fell was Dec. 2003.

Cai Qiusheng, an official with the State Administration of Foreign Exchange (SAFE), acknowledged in a speech on Saturday that the reserves had fallen from their level above $1.9 trillion, but gave no further details on the extent or timing of the fall.

What is behind the shift?

Economists said lack of transparency about the nature of capital flows in China made it just as hard to to explain the fall in October as it had been to account for stunning rises earlier in the year.

They listed a range of possible reasons behind the fall. One was that export firms and banks could be choosing to hold more dollars given their broad strength through November, another that more Chinese investments overseas could have been booked during that time.

Some economists cautioned, however, that it could also signal a potentially worrying reversal in capital flows.