Friday 29 Mar 2024
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This article first appeared in The Edge Financial Daily, on March 8, 2016.

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WHO is behind the exodus of capital from China? In popular imagination, it is foreign hedge funds and other investors dumping Chinese assets that caused US$1 trillion (RM4.07) of wealth to stampede out of the mainland in 2015.

But a new analysis by the Bank for International Settlements (BIS) points the needle of suspicion toward a more prosaic actor: the little fellow in Hong Kong, Macau, Singapore, Seoul and Taipei who is suddenly scared to park money in a yuan deposit in his neighbourhood bank.

The BIS study shows how a US$40 billion withdrawal of offshore yuan deposits in just these five locations during the third quarter of last year, presumably following the Chinese central bank’s nerve-rattling Aug 11 devaluation, may have triggered twice as big a reduction in these and other overseas banks’ own claims on mainland lenders.

That is US$80 billion gone from China in just three months, amounting to almost half the US$163 billion that moved out of the People’s Republic in cross-border transactions. (The People’s Bank shifted a further US$12 billion of its reserves to banks outside China, taking the total outflows during the quarter to US$175 billion.)

Now take the US$41 billion in foreign-currency debt repayment by Chinese companies to banks overseas and at home, and add it to the US$80 billion figure. The role of investors selling down yuan assets shrinks to a quarter of the total outflows.

Clearly, foreign depositors — and not investors — are driving the capital flight from China. This has three implications. One, the Chinese authorities encouraged the offshore yuan market to promote the use of yuan in global commerce even though it was not fully convertible. It all went swimmingly as long as depositors overseas were lured by the prospect of never-ending yuan appreciation against the US dollar.

That unspoken assumption is now broken. If the authorities in Beijing were to chase a rising dollar amid a slowing domestic economy, they would invite Japanese-style deflation — an unacceptable risk given the high level of corporate debt. Two, a strike by offshore depositors can be self-fulfilling.

As offshore banks move money out of China to meet their commitments to depositors overseas, the yuan could weaken further, reducing what is already a low rate of return on capital for foreign equity investors.

In a wobbly stock market, that could prompt further selling. That at least partly explains why China might delay a plan to liberalise its tightly controlled market for initial public offerings, lest it give investors another avenue to exit inefficient state-owned enterprises in favour of better-run private companies.

Finally, pump-priming could backfire. The budget deficit target of 3% of gross domestic product for this year, released on the opening day of the national legislature’s much-awaited annual session, is an increase from 2.3% in 2015. While the expansion may be welcome, with both fiscal and monetary policy loosening to revive growth, a bigger deficit could put the yuan under renewed downward pressure in the short run.

That might further deter overseas savers. Investor scepticism toward China’s reforms is a potential threat to the currency, but it is not the only one. Given their propensity for herd-like behaviour, a loss of faith among offshore depositors could be an even bigger problem. — Bloomberg

 

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