Forex activity hints at troubles ahead

Chinese banking institutions shelled out 38.7 billion yuan ($6.23 billion) on foreign exchange purchases in May, down from 116.9 billion yuan during the previous month and marking the smallest purchase total since August 2013, according to figures from the country's central bank.

This decline comes as a weaker yuan puts a damper on capital inflows. Still, this recent drop in forex spending may yet again amplify expectations of yuan appreciation, potentially stoking another round of currency speculation. To keep hot money at bay, the central bank is advised to keep exchange rates balanced at an acceptable level.

At the same time though, less foreign currency coming into the country means less liquidity in the money market. This could cause trouble for the real estate industry - not to mention small- and medium-sized enterprises in the real economy - which is already struggling with a scarcity of liquidity and severe funding constraints.

If China's forex spending continues to shrink, the central bank should consider a comprehensive reduction in banks' reserve requirements as a strategy to keep the economy stocked with cash.