After a strong performance in 2017, China's foreign exchange reserves are in a good position to maintain stability in 2018, providing support for the yuan.
The central parity rate of the Chinese currency strengthened 83 basis points to 6.4832 against the U.S. dollar Monday, putting the yuan in its strongest position since May 2016.
The rally came a day after the central bank announced the 11th consecutive monthly increase in forex reserves, expanding to 3.14 trillion dollars in December, the highest since September 2016.
Analysts attributed the growth to a weakening dollar, and improving economy, healthier trade and more balanced capital flows.
Reserves fell below 3 trillion dollars in January 2017, raising fears of decline and depreciation. However, as the economy got on a firmer footing and the government stepped up regulation of illegal capital transfers and overseas investment, reserves increased steadily, 4.3 percent in the whole year.
"It was about better economic fundamentals, recovering exports and, more importantly, reduced pressure on capital outflows due to a turnabout in expectations for the yuan," Shenwan Hongyuan Securities analysts Li Huiyong and Qiu Difan wrote in a research note.
China's GDP expanded an annualized 6.9 percent in the first three quarters of 2017. Q3 was the ninth straight quarter of growth over 6.7 percent.
A pick-up in exports has also been positive to forex reserves, said Liu Jian, researcher with the Bank of Communications. In the first 11 months of 2017, exports rose 11.6 percent.
Growing reserves tend to support to a nation's currency, and a stronger currency in turn encourages capital inflows and helps reserves increase.
The yuan's onshore exchange rate strengthened by 6.72 percent last year, the highest for nine years.
Liu believes a stable yuan will balance cross-border capital flows and help reserve growth in the near term. A falling dollar index and rising asset prices in Europe and the United States are also helpful.
The dollar index, which measures the greenback against six major peers, dropped 0.81 percent in December.
A report by the China International Capital Corporation (CICC), an investment firm, predicts moderate forex inflows and a stronger yuan in 2018, citing improving economic fundamentals and investment returns. However, the report cautioned that a strong yuan will be bad for exports and that outbound investment has recovered substantially, both limiting the room for further strengthening.
"Overall, the yuan will remain stable this year," the CICC report concluded.
