While financial markets have expressed concern about China’s rapid build-up of corporate foreign debt, estimated at US$1 trillion, or 9.3 percent of gross domestic product, many Chinese firms have started repaying their foreign borrowings since the second half of last year.
This is positive for China’s systemic stability, as it reduces its foreign debt burden — which is not heavy despite the market’s concern.
However, repayment of foreign debt can have a negative implication for the renminbi exchange rate, as Chinese companies have to sell renminbi and buy foreign currencies to repay their foreign debt.
The renminbi exchange rate is likely to remain under downward pressure for as long as Chinese companies continue to repay their foreign borrowings.
So if we know how much foreign debt the Chinese companies have repaid, we will be able to gauge how much more downward pressure the renminbi exchange rate will come under as the rest of this foreign debt is repaid.
Unfortunately, nobody knows for sure, because of the lack of proper borrowing records among Chinese companies.
However, there are a couple of clues (up to the third quarter of last year) that can help us make some estimates.
Firstly, the Bank for International Settlements (BIS) reported that banks’ claims on China fell by US$143 billion in the first three quarters of 2015, 75 percent of that in the third quarter alone.
This reflects repayment of China’s foreign bank loans by many Chinese companies that are switching to borrowing onshore to take advantage of lower borrowing costs and to reduce their foreign debt burden in the face of the renminbi’s depreciation.
Secondly, China’s balance of payments (BoP) data shows that net financial transactions in loans (including trade credits) and deposits (including receivables) in the first three quarters of 2015 recorded a deficit of US$330 billion.
The deficit in this category reflects repayment of foreign debt. Why?
When Chinese companies borrow overseas (including via trade credits), they incur a foreign liability, but that represents capital inflows, so it appears as a positive entry in the BoP.
Similarly, when foreign investors make deposits in China, these are capital inflows but represent a foreign liability for China.
On the other hand, when Chinese companies repay their foreign debt, and/or when foreign investors withdraw deposits from China, these transactions represent capital outflows and a reduction in China’s foreign liabilities and appear as negative entries in the BoP.
The large (US$330 billion) deficit in loans and deposits transactions suggests that repayment of foreign debt was the biggest driver of capital outflows last year.
So capital outflows stemming from the repayment of Chinese corporate foreign debt range between US$143 billion (based on the BIS data) and US$330 billion (based on China’s BoP financial account data), or between 14.3 percent and 33 percent of total Chinese corporate foreign debt.
It is likely that the true amount lies somewhere in between but closer to the 33 percent, as the BIS data only includes loans to China from its reporting banks.
Let us say the Chinese companies repaid 30 percent of their foreign debt in the past year.
If they keep up the same pace of repayment, the renminbi will remain under downward pressure for the coming two years, after which corporate foreign debt will be repaid, other things being equal.
Of course, other things are not constant.
Some market players argue that China’s capital outflows are getting out of control, as foreign reserves dropped by US$700 billion last year, despite a large current account surplus of US$293 billion.
There was also another US$132 billion in net capital outflows that could not be accounted for; these were recorded in the errors and omissions category in the BoP.
However, if there were uncontrollable capital outflows from China, this should have been seen in the loss of domestic deposits. This has not been the case, as domestic deposits are still growing at more than 10 percent a year, despite all the fears about massive capital flight.
In a nutshell, if global sentiment toward China remains negative, and if the US dollar continues to strengthen, repayment of foreign debt by Chinese companies will add downward pressure to the renminbi, which I expect to depreciate by another 3.5 percent against the US dollar by the end of this year from its current level of 6.5518 per US dollar.
However, if global sentiment toward China turns positive on signs of China’s economic stabilization and further easing of liquidity, and if expectations for US rate hikes and US dollar strength are tempered, the impact of China’s current account surplus on the renminbi may dominate again, and capital outflows may even reverse.
A falling renminbi is not a one-way bet.
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