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China’s capital outflows mean tweaking of controls

There was further confirmation from SAFE yesterday that the Chinese authorities will continue to tweak the current system of capital controls to discourage and prevent capital outflows intensifying even further. The recent pick-up in capital outflows has rekindled concerns about capital controls being extended while there have also been calls from several quarters for the authorities to let the CNY weaken to a new ‘equilibrium level’ in light of a Trump presidency (and its protectionist anti-China stance) along with a more hawkish Fed.

Also recall that last week PBoC adviser Fan reiterated that the government’s efforts to stem capital outflows have been effective and new measures are unlikely; adding that policymakers will not completely cease intervention in the FX market and the decline in FX reserves is good news in the long-term as large government foreign currency holdings are inefficient and the CNY’s inclusion in the SDR basket means that lower FX reserves are required.

We have been pointing to the resurgence in capital outflows as expectations of CNY depreciation have become entrenched because of the relenting, albeit relatively mild, pace of currency depreciation against the USD since the introduction of the more flexible ‘managed float’ exchange rate regime in August 2015 but we continue to think that the CNY will be allowed to carry on weakening against the USD, albeit only gradually.

Yesterday SAFE reported that banks’ FX sales were USD 46.3 billion in December, up from USD 33.4 billion in November but also said that the pressure from outflows in Q416 was not as severe as at the beginning of last year, another point we have been highlighting, but FX sales totalled USD 94.3 billion in Q416, lower by 43.0 percent y/y.

SAFE has now again promised to increase the monitoring of FX transactions and to continue the crackdown on illegal FX transfers with spokeswoman Wang also noting that fluctuations in the country’s official reserves were diminishing and the reserves were sufficient to cover external debt, repeating the official line that there is no justification for CNY depreciation in the long-term and short-term fluctuations in the exchange rate are normal.

In practice, the authorities are likely to continue to discourage the state-owned banks from carrying out FX transfers on behalf of corporates as well as individuals (without reducing the annual USD 50k FX purchase limit for now) while also leaning on exporters to remit back a bigger proportion of FX earnings as this ratio has dropped recently.

And, as we have been highlighting, the authorities have already announced a clampdown on investment abroad, especially by corporates, pressuring them not to invest in areas that do not fall within companies’ main operations with SAFE, the NDRC, the commerce ministry and the PBoC all tightening scrutiny of outbound investment.

This tougher approach has already had the desired effect with the commerce ministry reporting earlier this week that outbound direct non-financial investment was lower by 39.4 percent y/y in December (USD8.4 billion) after it surged by 76.5 percent y/y in November, although it was still up 44.1 percent in the whole of 2016 and at USD170.1 billion far exceeded FDI (which is likely to have been around USD120 billion in 2016, the data have not been released yet).

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