The other morning during a radio program, I mentioned that I thought there was significant risk that China would be introducing capital controls of various kinds in the not too distant future.
Given the huge amount of airtime given to the liberalisation of China’s capital account, I knew such a comment could prove controversial.
I wasn’t wrong. Some of the reactions I heard were of outright derision.
To avoid confusion we have to make some distinctions here, because the term “capital control” has a tendency to invoke a rather strong response.
At one end of the spectrum we have the ‘total crisis’ capital controls introduced in reaction to an economic emergency.
Some of the more notable examples include Malaysia in the late 1990’s Asian Financial Crisis, Iceland in wake of the 2008 Global Financial Crisis, and Cyprus in 2013 during the recent European crisis.
These are drastic (and typically shorter term measures) that are simply trying to ‘stop the bleeding’ as it were.
At the other end of the spectrum we have economies like China where capital controls are already a fundamental tool of existing economic policy.
So when I talk about capital controls in China, I’m referring to the implementation of stronger controls on capital flows.
Let me explain my thinking on this.
The evidence we see from certain actions from the China government tells me that it is not just a likelihood, rather it is already a reality.
Increased capital controls are already being put in place.
And the trends we see in capital outflows at a national level are likely to prove worrying to a leadership that is bent on keeping ultimate control of just about everything on the economic and financial front.
A perhaps small, but notable event on the control front occurred at the end of September.
China’s State Administration of Foreign Exchange (SAFE) implemented rules to limit the amount of cash withdrawals that holders of UnionPay bank cards can undertake outside China.
The new rules state that card holders can withdraw a maximum of Rmb 50,000 (approximately US$7,880) in the final quarter of this year.
And next year the limit is Rmb 100,000 (US$15,750) for the full year!
This is clearly a heightened control of capital.
Just think about the dire straits that Macau’s casino industry is in.
The official figures suggest some US$45 billion per year is washed through Macau’s casinos.
[One source I know who is an acknowledged expert on the inner workings of Macau suggest that the real number is more like five time that amount – close to a quarter of a trillion dollars per year! (I’m trying to line up a discussion with him which I can share with you. He has some fascinating insights as to what’s really going on in Macau… but there are things he’s told me that I know he’s not comfortable sharing with a wider audience… so I’m doing my best to convince him otherwise!]
Yes, the common wisdom is that the crackdown on Macau is the result of an anti-corruption drive. It may well be just as much about stemming this kind of capital outflow.
In September, Wang Yungui, head of policy and regulation at SAFE, indicated that SAFE will step up checks on companies’ buying of foreign exchange.
Demand for forex from some individuals and companies had gone beyond “the real and rational use” of such funds he recounts.
Banks are being instructed to enhance supervision of foreign exchange transactions.
I don’t know about you, but this sounds like controlling capital to me.
Mr Wang went on to tell us “The Yuan has become stable and there is no basis for large scale capital flows”.
Well, well! There it is then.
The facts tell a different story.
The fact that SAFE is engaging in these measures and this kind of talk indicates that the authorities are concerned about the rush of capital for the exit doors.
The numbers speak for themselves.
In August, China’s banks (including its central bank) sold US$113.9 billion of foreign exchange. That is the largest net sale ever.
The largest financial information provider in China, Wind Information estimates that net outflows are running at about US$135 billion per month.
Bloomberg reports the figure was higher still at US$141.66 billion.
Goldman Sachs estimates the outflows in August to be even higher at US$178 billion.
Whatever the real figure, this tells me that an awful lot of people are looking to get money out of China…
…and this is not a long-term sustainable trend.
But don’t worry…
Sheng Songcheng who heads up the statistics and analysis department of the Peoples Bank of China (PBOC) tells us “The current capital outflow is just a temporary market reaction”.
A reaction to what? The recent slight depreciation of the currency and the crash in the stock market are the standard reasons given.
I genuinely hope Mr Sheng is right but I am not quite so sure that this is going to prove as short term as he suggests.
I think there is another more murky reason for the increased desire to park as much money as possible offshore.
The need for an insurance policy.
President Xi’s massive anti-corruption program threatens to engulf just about anyone who has made money in any way.
This purge is targeting anyone and everyone… private entrepreneurs, employees of state owned enterprises or other government functionaries up to, and including the military.
No one is immune.
Parking money (and family) offshore in big numbers can provide such an insurance policy.
Real estate markets around the world are witness to the huge amounts of Chinese money that has been and still is flowing into bricks and mortar.
The Chinese demand for global real estate has not dissipated.
And the cash continues to flow out of China to pay for these assets.
[The Wall Street Journal did a nice little piece earlier this week showing how people in China are moving money offshore at a personal level. It’s worth a read.]
China’s foreign exchange reserves have taken a dive for the first time in recent history. SAFE reports that they fell by more than US$93 billion in August. Yes, a fall of this magnitude does not make a huge dent in a stockpile of around US$3.5 trillion.
But it is a worrying sign and could be a foretaste of much more to come.
When people want to buy foreign currency it means they are selling the local currency. That means the government needs to sell foreign currency (mainly US dollars) to meet this demand.
The Financial Times reports that China has recently been selling U.S. dollars at a rate of around US$20 billion per day.
At that rate, it would not take too long to make a big dent in the US$3.5 trillion war chest.
And ultimately this could put downward pressure on the Rmb.
The authorities are in a difficult position. If they act harshly to stem capital outflows that could send a negative signal to the market which could react with even greater demand for foreign currency and selling of Rmb.
If they don’t do anything it seems likely from where we stand right now, that cash will continue to drain out of the country.
The Chinese don’t want to see a big rundown of their foreign exchange reserves. But they equally do not want to see a sharp retreat of the currency.
Another tricky balance is required when it comes to easing measures.
As we have long predicted, the PBOC has continued to lower desposit and lending rates to stimulate the economy. However, as these rates come down, the Rmb becomes decreasingly attractive for onshore investors… and offshore assets start to look more attractive.
My guess is that China will continue to increasingly implement incremental measures to crack down on capital outflows… especially at an individual level…
… BUT, It is highly unlikely to be done in one big draconian step, rather a series of smaller, targeted, less obvious but measured actions.
This would also be in keeping with traditional incremental polices that the authorities tend to favour as a general rule. Try something, see if it works and if not, try something different.
Either way, although the large outflows we’ve seen over the past 12-18 months are slightly worrying, there’s absolutely no reason for panic yet.
(We see ‘panic’ all the time… remember the reaction we saw to the sudden depreciation in China’s currency? Nearly every single major media outlet started talking about ‘currency wars’… and what’s happened since then? The Rmb has appreciated against the dollar! You can see our original analysis here.)
Subscribers to The Churchouse Letter will recall in our August edition (“The Biggest Market You’ve Never Heard Of“), we said we would be watching the currency and capital flows very closely as it was important to our recommendation for that month, which remains a Buy.