We’ve written quite a bit over the past two months about capital outflows from China. Last week for instance, we documented [7] how the country saw its fourth consecutive quarter of outflows in Q1, bringing the 12 month running total to some $300 billion. Why, beyond the obvious, is this a problem for China? Because pressure is mounting to devalue the yuan as the currency’s peg to the recently strong dollar is becoming costly for the country’s export-driven economy.
Here’s Soc Gen’s Albert Edwards [8] on the subject:
In the current deflationary environment the Chinese authorities simply can no longer tolerate the continued appreciation of their real exchange rate caused by the dollar link.
And from Barclays:
Amid slowing inflation and rising outflows, the costs of limiting CNY weakness are growing – including the unintended effect of placing more stress on CNY market liquidity and interest rates, rendering liquidity easing efforts less effective.
And here is how we summed up [9] the situation last month:
China is suddenly finding itself in an unprecedented position: it is losing the global currency war, and in a "zero-sum trade" world, in which global commerce and trade is slowly (at first) declining, and in which everyone is desperate to preserve or grow their piece of the pie through currency devaluation, China has almost no options.
At issue is the fact that expectations about the direction of the yuan may be contributing to capital outflows and any indication on the part of Beijing that devaluation is in the cards could exacerbate the problem. Now, data from SAFE suggests nearly $24 billion left China in March alone. Here’s more, via Bloomberg [10]:
Here’s another Chinese puzzle. Economic growth, while slowing, is still 7 percent and the stock market is on a tear. Yet money is leaving the country.
That’s a turnaround for an economy that’s been a magnet for foreign capital during the boom years of the past decade. Why the outflow? A property bust, squeezed corporate profits and the end of a multi-year currency upswing are giving investors fewer reasons to pile in. At the same time, President Xi Jinping’s crackdown on corruption gives more reasons for the nation’s rich to squirrel some of their wealth abroad.
All of this is happening as China moves ahead with initiatives making it easier to move money in and out of the country. While far from levels seen most recently in countries such as Russia, the trickle of cash now exiting China raises a warning flag for what could happen during any domestic financial crisis, as China works to deleverage its economy.
“We have both a booming stock market and capital outflows, which is counterintuitive,” said Jean-Charles Sambor, Asia-Pacific Director at the Institute of International Finance in Singapore. “The downside risk would be to have broad-based outflows if the macro story deteriorates further or the stock exchange collapses, which would create a confidence crisis.”
One measure released by SAFE on Thursday showed that a net $23.8 billion left the country in March, the most in at least a year. Foreign-exchange reserves slid the most on record in the last three months, fueling speculation the central bank was forced to sell some of its dollar holdings to support China’s currency, the yuan. In the final quarter of last year, the capital account posted its widest deficit since at least 1998.
And here’s Goldman with more on the March outflow:
SAFE data shows that banks net sold $58bn in FX to Chinese non-banks in March (up from $10bn in February). This is the largest such FX net sale since the data began in 2001…
The $58bn net sale in FX covers settlement of previously-entered forward contracts due during the month as well as outright spot transactions. If we instead look at the sum of outright spot transactions and freshly-entered (but unsettled) forward contracts, the scale of net FX sales was even larger at $70bn.
Data on the monthly change in the position for FX purchases for the whole banking system (the PBOC plus commercial banks) released by the PBOC earlier showed a smaller FX outflow of $25bn...
Both the SAFE and PBOC data do suggest a pickup in FX outflow in March. This seems consistent with market views that the PBOC heavily intervened around mid-March to engineer a visible CNY appreciation, ahead of the subsequent rapid reduction in domestic interbank interest rates.
Looking ahead, while we may continue to see significant capital outflow in coming months, we believe the PBOC will remain committed to maintaining a broadly stable USDCNY exchange rate, including by open market FX operations as needed.
Bloomberg goes on to note that an unravelling of the country’s world-beating equity rally could lead to further outflows as could rising rates in the US and the above-mentioned devaluation fears:
If yields on Treasuries spike higher as the Fed tightens -- as has sometimes happened in the past -- the U.S. could lure money from developing economies like China.
Then there’s the currency risk. In the case -- unlikely for now -- that the yuan is allowed to weaken substantially to boost exports, that could trigger the unraveling of carry trades estimated at $1 trillion.
To be sure, not all of the departing capital is speculative, or so-called hot money. Much of it is actually a sign of China’s increased economic development, such as outward investment as companies expand their global footprint.
As a reminder, here’s a look at “hot money” outflows via Barclays...
[11]
...and here's a look at the bigger picture via JPM:
[12]
Summing up, China faces accelerating capital outflows, a looming economic downturn, and an epic stock market bubble, and ironically, efforts to combat the latter two problems are very likely to exacerbate the former. Or, as one strategist told Bloomberg: "China is nowhere near a crisis, but like the parable about the frog in a pot, the water is getting closer to a boil."
