Conventional wisdom has it that the renminbi has come under severe depreciation pressure due to capital flight and that it is likely to have a serious negative impact on China’s financial system.
Some market players have estimated that China’s non-FDI capital outflows amounted to US$160 billion in Q4 2014 and to more than US$320 billion for the full year. The figures include capital flight, hot money (portfolio investment) outflows, net trade credit flows and net foreign borrowing by Chinese companies. Yet there is no solid data for capital flight.
Meanwhile, data from the People’s Bank of China (PBoC) shows that net FX purchases by onshore banks fell on a month-on-month basis in both December 2014 and January 2015, despite a record trade surplus of US$109.6 billion in the same period.
The decline, totalling US$36.5 billion for the two months, was the largest cumulative two-month drop on record, implying net capital outflows. The drop in FX purchases might also reflect a hoarding of foreign currencies, mainly by onshore companies, due to the fear of renminbi depreciation. Indeed, foreign-currency deposits jumped sharply, by more than US$82.2 billion in January 2015 from a cumulative decline of US$50.6 billion in the last quarter of 2014.
Fuelling the worry about capital flight, China’s director of international payments at the State Administration of Foreign Exchange, Guan Tao, was recently quoted as saying that capital outflows from China were akin to the situation before the 1997 Asian crisis, when money flight accelerated. Other observers have also cited the decline in China’s FX reserves by US$150 billion in H2 2014 as evidence of capital flight.
Indeed, large capital outflows are one of the three factors we have highlighted for detecting a change in the underlying trend of the renminbi, the other two being a persistent deterioration in China’s external balances and a change in the PBoC’s FX policy stance. The risk of capital flight is real, but it is a long-term structural issue. The evidence of capital outflows so far remains both preliminary and sketchy.
China’s relatively closed capital account makes capital flight manageable. It also buys time for structural reforms to fix the problems that underlie capital flight.
Observers have cited the evidence of capital flight in isolation, which tends to skew any analysis of China’s financial and FX risks. These analyses have exclusively focused on the near-term decline in FX reserves and FX purchases by the onshore banks. They have failed to discuss the most important aspect that China’s FX reserves still recorded a net increase of US$22 billion in 2014.
Granted, this was the smallest increase in FX reserves in the past fourteen years. But it is also an undeniable fact that there were net capital inflows to China last year, despite some outflows in the final quarter. These inflows would have pushed up the renminbi against the US dollar in 2014 if the PBoC had not intervened early in the year to squash one-way bet on RMB appreciation. Focusing on selected outflow data only provides a partial view, not the full picture.
As we expected, China’s current account surplus is turning around, with the rising trend likely to continue due to falling cost for oil imports. Steady net foreign direct investment in China will boost China’s basic balance (current account + net long-term capital inflows), which amounted to over 4 percent of GDP in 2014, to support the renminbi’s external value.
What about China’s overseas direct investment (ODI), which has increasingly become a crucial source of capital outflow? While ODI has been national policy since year 2000, and has risen 13-fold since 2003, it remains too small to have any material impact on the overall net capital flow trend.
ODI amounted to an estimated 0.13 percent of GDP in 2014, up from 0.01 percent in 2004, and is less than a third of the size of FDI inflows. Given the risk of capital flight, Beijing is unlikely to boost ODI significantly in the medium-term. Net FDI inflows will continue to augment the basic surplus.
In a nutshell, China’s capital flight is not yet a major problem. However, it is a risk that needs to be monitored closely. If it were to increase persistently and overwhelm capital inflows, it would destabilize China’s financial system and put significant downward pressure on the renminbi. To prevent this, Beijing is unlikely to open the capital account swiftly anytime soon.
The opinions expressed here are of the author’s and do not necessarily reflect those of BNPP IP.
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