China’s yuan holdings for purchasing foreign exchange - an indicator of capital flows - grew in May, according to data released by the People’s Bank of China on June 19.

According to the central bank, yuan positions went up by 23.4 billion yuan ($3.68 billion) to 25.61 trillion yuan last month, compared to the 60.6 billion yuan decline in April, the first monthly drop since the beginning of the year.

The increase in May is the smallest monthly growth in nearly 10 years, but it indicates that capital is flowing back to China despite concerns over the economic slowdown amid the European debt woes.

Zhou Xiaochuan, the central bank governor, said earlier that PBOC moves, such as reductions of the reserve requirement ratio for commercial lenders, are closely related to the yuan positions for purchasing foreign reserves.

In the fourth quarter of 2011, holdings declined for three consecutive months, indicating that capital withdrew from the world’s second-largest economy amid rising global uncertainties and lower forecast growth for China.

The increase of yuan holdings for foreign exchange purchases will further decline in the next half year as expectations of yuan depreciation strengthen, China International Capital Corp Ltd said in a report.

Since May, the yuan has depreciated against the dollar by more than 1 percent.

However, China’s exports will likely remain weak in the remainder of the year, and as a result, the trade surplus could narrow significantly, said Liu Ligang, head of China economics at the Australia and New Zealand Banking Group Ltd.

This means that two-way volatilities in the yuan exchange rate could increase significantly led by the directions of net capital flows, he said.

“We think that net capital outflows will be a healthy development that will help deflate an asset bubble and an overvalued exchange rate,” he added.

[email protected]