As China's foreign exchange reserves threaten to tumble below the critical $3 trillion mark, the biggest fear for investors is not whether Beijing can continue to defend the yuan but whether it will set off a vicious cycle of more outflows and currency depreciation.
Data this week is expected to show China's forex reserves precariously perched just above $3 trillion at end-December, the lowest level since February 2011, according to a Reuters poll.
While the world's second-largest economy still has the largest stash of forex reserves by far, it has been churning through them rapidly since August 2015, when it stunned global investors by devaluing the yuan and moving to what it promised would be a slightly freer and more transparent currency regime.
Since then, authorities have repeatedly intervened to support the yuan when it weakened too sharply, burning through half a trillion dollars of reserves and prompting them to sell some of their massive holdings of U.S. government bonds.
They also have put a tightening regulatory chokehold on individuals and businesses who want to move money out of the country, while denying they were imposing new capital controls.
Concerns over the speed with which China is depleting its ammunition are swirling, with some analysts estimating it needs to retain a minimum of $2.6 trillion to $2.8 trillion under the International Monetary Fund's adequacy measures.
"There has been quite a bit of anxiety and speculation because the way many people in China talk about it is 'will the government defend the 7-per-dollar level or the 3 trillion dollars'," said Louis Kuijs, head of Asia economics at Oxford Economics in Hong Kong.
China stepped into both its onshore and offshore yuan markets this week to shore up the yuan as it neared the 7 level, sparking speculation that it wants to regain a firm grip ahead of the Jan. 20 inauguration of U.S. President-elect Donald Trump, who has threatened to brand Beijing a currency manipulator.
But if forex reserves continue to be depleted at a fast pace and capital flight continues, some strategists believe China's leaders may have little choice but to sanction another big "one-off" devaluation.
That could set off competitive currency devaluations by other struggling emerging economies, even as the world braces for greater trade protectionism under Trump.
To slow the yuan's decline without depleting reserves at an ever faster pace, analysts and economists expect authorities to turn to even tighter regulatory measures, including more scrutiny of outbound investments, overseas lending and export revenues, and closing loopholes in existing capital controls.
But as fast as authorities jump to control one exit ramp, others may open up unless Beijing can reverse the market's mind-set that the yuan is on a one-way depreciation path.
"It doesn't matter if there's actually enough reserves or not," said Joey Chew, Asia foreign exchange strategist at HSBC, who believes China doesn't need a buffer of more than $2 trillion.
"If people think there won't be enough they'll try to get out and it becomes a self-fulfilling mechanism.
"The authorities are already aware that trying to run down reserves will be counterproductive, which is why they're relying on regulatory controls," she added.
As recently as last week, authorities introduced requirements for financial institutions to report all single domestic and overseas cash transactions of more than 50,000 yuan ($7,212.72) from July onwards, down from 200,000 yuan previously.
The authorities also stepped up scrutiny on individual foreign currency purchases, although they kept the $50,000 annual individual quota in place.
"Previously, capital controls had been relatively loose and authorities had turned a blind eye to individual forex purchases because of abundant foreign exchange reserves," said Jerry Hu, an economist at Shanghai Securities.
"But they are now strengthening supervision in order to change expectations."
With regulators also pledging to increase scrutiny of major outbound deals, "it's not impossible to see that we'll see further moves in that area," Kuijs said.
China could also encourage its domestic exporters to convert more of their earnings into yuan, HSBC's Chew said.
Chew believes new capital controls are unlikely.
"There are a lot of controls already," she said. "They were maybe not as strictly enforced, so they'll focus on improving that. But the tweaks may not be enough. We still expect capital outflows and we still expect RMB depreciation."
Dwyfor Evans, head of Asia-Pacific macro strategy at State Street Global Markets, also feared authorities may be limited in how they respond.
"Chinese officials have few policy options," he said.
"If they allow faster depreciation, this will only spur pressures for greater outflows. And a one-off devaluation risks a repeat of the market turbulence evidenced twice in the past 18 months."
© 2022 Thomson/Reuters. All rights reserved.