Chinese Capital Outflows Return As Soon As PBOC Halts FX Intervention

Since the addition of the Chinese renminbi (RMB), i.e. Yuan, to the IMF’s SDR basket of reserve currencies last October, more than 60 countries and regions have added and adopted the renminbi as a new reserve currency, according to the latest report on renminbi internationalization by the People’s Bank of China.

As a reminder, one year ago the International Monetary Fund included China’s currency in its Special Drawing Rights basket as an international reserve currency, along with the U.S. dollar, the euro, the Japanese yen and the British pound. As the PBOC gloated, this inclusion further promoted the international use of RMB, which is ironic considering in the past year the Chinese central bank unleashed some of the most draconian capital controls and measures to avoid capital flight, going as far as effectively banning offshore M&A (not to mention bitcoin trading) which Beijing saw as just another way to avoid China’s capital account firewall. Meanwhile, to “lead by example” the ECB invested €500MM of its reserves in renminbi-denominated assets during the first half of this year.

The PBOC also said “it will push forward with internalization of the renminbi and keep its position stable in the global monetary system.”

“Looking ahead, the scope of international usage of renminbi will be further expanded in 2017 and usage channels will be further widened” the report said. 

“Renminbi internationalization will play a more active role in serving the real economy and facilitating trade and investment.”

Supposedly that means that the next time the Yuan crashes once people remember that of China’s $30 trillion in loans, roughly 20% are NPL, the PBOC will not intervene when tens of billion in capital resume fleeing every day.

Somehow we doubt it, especially since as the report itself admitted, the value of trade deals settled in the renminbi fell by 35.5% in 2016 from the previous year. Renminbi settlement accounted for 16.9% of China’s total goods trade last year, while the proportion was 22.6% in 2015, 20% in 2014, and close to zero in 2009. The currency fell by 6.5% against the dollar in 2016 – the biggest annual drop since 1994, but gained about 5% this year due to dollar weakness and tighter controls on capital outflows.

And speaking of capital flight, even though the PBOC reported that in September official central bank reserves rose by $17 billion to $3.109 tn (largely due to valuation effects), according to the latest SAFE data released overnight, after the first, and only month of inflows in three years, outflows have again returned for a total of $7bn in September (vs. net inflows of +US$9bn in Aug), in light of the recently relaxed FX forward rule (recall “Yuan Tumbles After Beijing Gives Speculators Green Light To Short The Currency” from September 8)

Below are the details from Goldman:

Our usual preferred gauge of underlying flows suggests a total net FX outflow of US$7bn in Sep (US$2.4bn from net FX demand onshore plus US$4.9bn in FX outflow routed through the CNH market).

• According to the SAFE dataset on “onshore FX settlement”, net CNY demand by non-banks onshore in Sep was -US$2.4bn (vs. +US$3.1bn in Aug). This is composed of +$5.1bn net inflows via net outright spot transactions and net outflow of US$7.5bn via net freshly-entered forward transactions. In particular, demand for short-CNY forwards rose significantly (from US$10bn in Aug to US$28bn in Sep), following the cut of reserve requirement for sales of FX derivatives to zero in early Sep, which made it less costly for onshore entities to hedge against CNY.
• Another SAFE dataset on “cross-border RMB flows” shows that net flow of RMB from offshore to onshore was -US$4.9bn in Sep (vs. +US$5.8bn in Aug).

Exhibit 1 the usual gauge of FX flows suggests a small net outflow of US$7bn in Sep

Related, another data set called PBOC’s FX position (also released today) suggests no net FX purchases by the PBOC in Sep (in contrast with the earlier released FX reserve data that implies about $17bn in FX purchases).

Two notes in terms of flow pattern for Sep:

Foreigners’ investment in domestic fixed income products remained solid, rising by US$15bn in Sep according to bond custodian data (Exhibit 2), following a $12bn increase in Aug. But similar to the previous month, a large portion of this inflow was into domestic NCDs, which could reflect short-term arbitrage activity driven by the rate spread implied by CNH cross-currency swap and domestic NCD yields.

Exhibit 2: Bond inflows were large in Aug and Sep, although a majority of these were into short-term NCDs

Trading firms repatriated a larger portion of their trade surplus back onshore, up to 84% in Sep, from 59% in Aug and the average of 40% in the last two years. The absolute amount though was roughly flat vs. Aug (at c. $24bn).

Separately, in a conference held on the sidelines of the Party Congress, Governor Zhou downplayed the pace of FX and outflow liberalization going forward. He said that the transition to CNY free convertibility is a long-term process; and that CNY band widening would signal more FX reform in future, but this is currently not a policy focus. In the near term, the authorities may continue to use a combination of daily guidance (via the fixing’s countercyclical factor) and occasional reinforcing FX intervention to manage the CNY, in our view.

In other words, capital controls are here to stay, and the moment outflows go back to double digit territory, the PBOC will unleash all hell against the Yuan short all over again.