[HONG KONG] Here's another Chinese puzzle. Economic growth, while slowing, is still 7 percent and the stock market is on a tear. Yet money is leaving the country.
That's a turnaround for an economy that's been a magnet for foreign capital during the boom years of the past decade. Why the outflow? A property bust, squeezed corporate profits and the end of a multi-year currency upswing are giving investors fewer reasons to pile in. At the same time, President Xi Jinping's crackdown on corruption gives more reasons for the nation's rich to squirrel some of their wealth abroad.
All of this is happening as China moves ahead with initiatives making it easier to move money in and out of the country. While far from levels seen most recently in countries such as Russia, the trickle of cash now exiting China raises a warning flag for what could happen during any domestic financial crisis, as China works to deleverage its economy.
"We have both a booming stock market and capital outflows, which is counterintuitive," said Jean-Charles Sambor, Asia- Pacific Director at the Institute of International Finance in Singapore. "The downside risk would be to have broad-based outflows if the macro story deteriorates further or the stock exchange collapses, which would create a confidence crisis."
So far at least, officials are playing down the risk. Guan Tao, head of the State Administration of Foreign Exchange's international payment department, on Thursday said the outflows weren't surprising and that authorities aren't considering new measures to clamp down on departing money.
One measure released by SAFE on Thursday showed that a net US$23.8 billion left the country in March, the most in at least a year. Foreign-exchange reserves slid the most on record in the last three months, fueling speculation the central bank was forced to sell some of its dollar holdings to support China's currency, the yuan. In the final quarter of last year, the capital account posted its widest deficit since at least 1998.
One trigger to accelerate the outflow could be a steep correction in stock prices that spurs domestic investors to seek safety in overseas assets. The Shanghai Composite Index has soared about 90 per cent over the past six months as the central bank cut interest rates and took steps to revive lending growth.
"Capital outflows from China are likely to increase as the opportunities for high returns decline due to the collapse of the property bubble and the increasing crackdown on illegal gains due to Xi Jinping's anti-corruption campaign," said Andrew Collier, managing director of Orient Capital Research in Hong Kong.
Another flashpoint: a US Federal Reserve rate increase. If yields on Treasuries spike higher as the Fed tightens - as has sometimes happened in the past - the US could lure money from developing economies like China.
Then there's the currency risk. In the case - unlikely for now - that the yuan is allowed to weaken substantially to boost exports, that could trigger the unraveling of carry trades estimated at $1 trillion.
To be sure, not all of the departing capital is speculative, or so-called hot money. Much of it is actually a sign of China's increased economic development, such as outward investment as companies expand their global footprint.
The government itself is actively helping drive such movement as it pushes its "One Belt, One Road" strategy to invest in neighbors along the historic Silk Road sea and land trade routes. It picked a dam project in northern Pakistan for its first investment, according to a government statement this week.
Chinese billionaire Guo Guangchang, the founder and chairman of Fosun Group, China's largest closely held conglomerate, said in an interview Thursday that the company was planning further overseas acquisitions.
"I do not see it as a systemic risk," said Frederic Neumann, co-head of Asian economics research in Hong Kong at HSBC Holdings. "They do have capital controls at the end of the day - it is not that easy to take money out."
While China's capital account is still largely closed, meaning investors and companies need permission to shift money in and out of the economy in any sizable quantity, restrictions are easing. New free-trade zones are starting, on top of existing areas such as Shanghai's, making it easier for companies to shift cash beyond China's borders.
Meanwhile, China is pressing ahead with liberalisations as part of its aim to win reserve-currency status from the International Monetary Fund when it conducts its once-in-five- year review later in 2015.
Up China's sleeve is plentiful ammunition to fight speculators if it ever came to a crisis. The People's Bank of China can lower the amount of reserves banks must hold, pumping cash into the system to offset outflows. Then there's the US$3.73 trillion pot of foreign currency reserves it can use to shore up the yuan, as analysts say it did in the first quarter.
"If there is an economic crisis, my guess is that the fear-driven outflows could rise sharply, putting immense pressures on the PBOC's foreign reserves," said Stephen Jen, co-founder of SLJ Macro Partners LLP in London and a former IMF economist. "But the foreign reserves are there for a reason, precisely to meet this contingency."
While regulators like SAFE keep a tight grip on how money can leave the country, investors cook up methods to sidestep the rules. One favorite option has been the use of fake invoicing for overseas trade or services that were never transacted. Collier of Orient Capital Research estimates that the deficit for outward over inward services almost doubled to US$198 billion in 2014.
"China is nowhere near a crisis, but like the parable about the frog in a pot, the water is getting closer to a boil," said Mr Collier.