Just two days ago, we took another look at the various means by which Chinese citizens circumvent Beijing’s capital controls. As a reminder, Chinese are only allowed to move up to $50,000 from the country in any given year, presenting a problem for anyone trying to dodge an export-boosting, double-digit deval or for anyone just trying to smuggle a few million out to buy an overpriced penthouse in Manhattan.
Previously, you could use your UnionPay card to “buy” a Rolex in a back alley in Macau, but Chinese authorities finally tired of that charade and cracked down on the UnionPay end-around last year. Thankfully, there’s “Mr. Chen” and his “yellow loafers”, tea, and Snickers bars. In short, as long as you know the right shady go-between, you too can pay Chen 3% to move your money to Hong Kong, where it will be out of Beijing’s reach and free to go where it pleases.
As we’ve noted on any number occasions, capital controls are to some extent counterintuitive. That is, the stricter the capital controls, the more people want to move their money out of the country. Here’s how we put it last month: “What better way to spark a capital exodus than with very vocal, and very effective capital controls. Just look at Greece.”
Indeed, China will likely need to completely liberalize the capital account in the coming years in order to pacify the IMF which is poised to throw Beijing a bone and grant its RMB SDR bid. Inclusion could lead to some $500 billion in reserve demand.
That helps to explain why overnight, the yuan soared the most in a decade after China moved to loosen capital controls with a trial program in the Shanghai free trade zone that would allow domestic individuals to directly buy overseas assets. The move marks another step towards capital account convertibility, thus bolstering Beijing’s bid for yuan internationalization. The result:
Put simply: when you stop telling people they can't move their money around, there's a good chance they'll stop moving their money around and that means reduced capital flight and in turn, a stronger yuan. Here's Bloomberg:
China’s central bank said Friday that it will consider a trial program in the Shanghai free trade zone allowing domestic individuals to directly buy overseas assets. The nation may dismantle capital controls by 2020, people familiar with the matter said last week, as President Xi Jinping’s government seeks to open up mainland markets to international investors and elevate the yuan’s status on the global stage.
“These policy initiatives are another important step toward complete capital account liberalization,” Zhou Hao, a senior economist at Commerzbank AG in Singapore, wrote in a note. “Clearly, it shows that China could accelerate financial market reform.”
The PBOC first mentioned the so-called Qualified Domestic Individual Investor program for direct overseas investments in a January 2013 statement. An existing program allows individuals to buy securities abroad through asset managers and funds.
Friday’s statement on the Shanghai FTZ, which was issued jointly with several government departments, suggests regulators aren’t far from implementation, said Becky Liu, senior Asia rates strategist at Standard Chartered in Hong Kong.
“This maps out the overall framework of not only FTZ developments, but also the overall direction of China’s capital-account opening in the coming quarters,” Liu said.
Meanwhile, the PBoC looks to have intervened offshore in an effort to close the spread between the onshore and offshore yuan. The gap has widened of late after largely disappearing in September, which telegraphs the market's expectations for further yuan weakness.
The Chinese currency also got a boost from suspected intervention in the offshore market as authorities seek to align the exchange rate with prices in Shanghai, a move seen as increasing the odds of an endorsement from the International Monetary Fund. The yuan gained 0.62 percent to 6.3175 a dollar in onshore trading and added 0.39 percent in Hong Kong.
The question, it would seem, is whether loosening capital controls and thereby increasing the chances that the yuan will become further embedded in global trade and investment will be enough to offset to impulse to move money out of the country. As Citi's head of emerging market economics in London David Lubin put it earlier this week, "SDR inclusion makes the RMB, by definition, a 'reserve asset', and this should catalyse capital inflows to China, but by how much, it's hard to say. And since China should expect to see gross capital outflows for the foreseeable future, it's not even clear that SDR inclusion will lead to a net capital inflow to China."
No, it's not, because between an imploding economy, expectations that Beijing is ultimately targeting a 20% devaluation in order to boost said imploding economy, and speculation that the banking system is sitting on trillions in NPLs (as we've documented extensively, the headline figures for sour loans are likely understated to the point of absurdity), more and more locals are likely to visit "Mr. Chen" in the months and years ahead. Or they'll just opt for the easiest way to move money out of the country of all...