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China money outflow goes quiet, for now, as stability reigns

Wednesday, August 10, 2016 - 11:56
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A year after global markets were shaken by a surprise China devaluation, they are now becalmed, and pressures for an exodus of capital from the nation have eased.

[HONG KONG] A year after global markets were shaken by a surprise China devaluation, they are now becalmed, and pressures for an exodus of capital from the nation have eased.

Diminished expectations for US interest-rate increases have helped stem the tide. Authorities also have cracked down on savers squirreling money out through everything from dubious invoicing to purchases of overseas insurance products.

On the economic front, stability reigns for now. The nation's foreign exchange reserves have levelled out at around US$3.2 trillion, and data Tuesday showed a streak of factory-gate deflation may be coming to an end after more than four years.

Other indicators suggest overall economic growth is holding up and the People's Bank of China has signaled it isn't in a hurry to cut interest rates, even as it adds stimulus through other channels.

Authorities soothed concerns by promising not to devalue the yuan in order to help exporters. Even as the yuan has weakened about 2.4 per cent against the dollar this year, markets have grown comfortable with the country's new trading mechanism - taking panic out of the equation.

Having said all of that, cash is still leaking out of the world's No 2 economy. That means worries won't go away that sudden yuan weakness could trigger another burst of destabilising capital outflows.

"All it takes is one snowballing rumour of policy change or further renminbi devaluation to trigger the next rush for the doors," said Pauline Loong, managing director at Asia-Analytica Research in Hong Kong.

"The domestic mood is one of worry and uncertainty."

Case in point: when the yuan fell about 1 per cent against the dollar and 2.2 per cent versus a trade-weighted index in June, some US$49 billion worth of foreign exchange flowed out, up from US$25 billion in May, according to Goldman Sachs Group Inc.

Analysis by Nomura Holdings Inc of Chinese imports in the six months through June found that capital outflows may have been disguised as imports from tax-haven and offshore financial centres.

Shipments from Samoa soared 723 per cent over the period and those from the Bahamas rose 354 per cent, according to the Nomura analysts led by Yang Zhao. At the same time, overall imports fell.

It isn't just suspicious imports that are being used to get money out from China. Companies are fabricating business transactions in places like the US, according to Dan Harris, a Seattle-based lawyer and founder of Harris Moure LLP who specialises in providing legal assistance to companies doing business in China.

"There are fake deals, lots of them," Mr Harris said, adding that his firm routinely turns down transactions it deems suspicious.

In one case in February, a person claiming to advise a Chinese manufacturer asked him if Mr Harris's firm could orchestrate a fake arbitration proceeding in the US for a US$3.5 million breach of contract.

The Chinese company wanted Harris to set up a US company and help fabricate a case to convince Chinese regulators that it needed to get money out of China to pay "damages" to the US company.

Other tactics used by Chinese companies include paying for overseas consulting contracts that don't deliver any services, fabricated technology licensing agreements with overseas providers, or the fake acquisition by a Chinese company of an offshore entity, Mr Harris said.

The Ministry of Commerce and People's Bank of China didn't immediately respond to a request for comment. The State Administration of Foreign Exchange said it couldn't immediately comment.

The weakening yuan also prompted China's investors to pile into equities in Hong Kong, where the currency is pegged to the greenback. Mainland traders have bought a net 93.1 billion yuan (US$14 billion) of shares listed on the city's stock exchange this year, according to data compiled by Bloomberg tracking investments via the exchange link with Shanghai. By contrast, net inflows into mainland equities via the two-way channel have amounted to 26.6 billion yuan in the period.

Much of the money that has left China is still unrelated to capital flight. Companies have paid down foreign debt and have pursued legitimate investments. The outflows also reflect asset diversification and parents paying for their children's education abroad.

It's also been a record year for Chinese companies buying overseas assets, with US$157.2 billion of announced deals so far this year. That volume of activity hasn't gone unnoticed by China's regulators, who have increased their scrutiny of foreign acquisitions and in some cases have blocked deals outright.

Still, even as money heads out through some channels, it's coming in via others. Foreigners' holdings of Chinese stocks climbed to the highest in a year in June.

Bond inflows that month also rose the most since 2014 as the government increased overseas access to the market and the nation's relatively high yields lured investors.

China also has a healthy trade and current account surplus to act as a buffer, said David Loevinger, a former China specialist at the US Treasury who is now an analyst at fund manager TCW Group Inc in Los Angeles.

"So even if it has net capital outflows, as long as they're not too big or too sudden, then I think China and the PBOC can manage it," Mr Loevinger said.

The ballgame may change should the US Federal Reserve resume raising interest rates more aggressively than currently forecast, strengthening the greenback and weakening the yuan.

Then there's the risk of policy error.

"If something shocking happens like last August or early this year, when everybody was worried about the systemic risk of China, then this process will definitely accelerate, leading to panic capital flight," said Harrison Hu, chief greater China economist at Royal Bank of Scotland Plc, referring to the process of asset diversification.

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