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Forex reserves stabilize, but pressure persists to move funds offshore

2016-July-11       Source: ecns.cn

The pace of China's capital outflows has slackened thanks to the country's effective capital controls and the valuation effects in non-dollar assets.

Forex reserves stabilize, but pressure persists to move funds offshore

The pace of China's capital outflows has slackened thanks to the country's effective capital controls and the valuation effects in non-dollar assets. Yet, capital outflow pressure has persisted. Any sign of a US interest rate hike, which would strengthen the dollar against other currencies, could cause companies and individuals to move money offshore. And authorities don't have a lot of moves left to take on the problem, experts said.

The pace of China's capital outflows has stabilized, for now, thanks to the country's effective capital controls and the valuation effects of non-dollar assets.

China's foreign exchange reserves grew unexpectedly by $13.5 billion to $3.21 trillion in June, marking the biggest monthly gain since April 2015, central bank data showed on Thursday.

China's foreign exchange reserves shrank to $3.19 trillion in May, their lowest since December 2011, so the June increase appeared to calm concerns about capital flight, which would likely cause further depreciation of the yuan and eventually wipe out China's foreign currency reserves.

Data from the central bank showed that China's forex reserves fell by $125.2 billion in the first half of this year, far less than in the latter half of 2015, when they plunged by $420 billion, unsettling global markets.

China's forex reserves seem more stable so far this year, partly because Chinese corporations no longer repay their foreign debt, which may be linked to a more stable exchange rate, Marie Diron, a senior vice president at Moody's, told the Global Times Thursday.

Yet, capital outflow pressure has still persisted. Any sign of an interest rate increase from the US Federal Reserve, which would strengthen the dollar against the yuan and other currencies, could spark a fresh round of companies and individuals moving money offshore, experts warned. And authorities have little in the way of policy ammunition to combat capital flight.

Data differences

Generally speaking, changes in China's forex reserves have been an important indicator for the global market to find out what's happening to China's capital flows. But experts pointed out that forex reserves cannot reflect the true scale of capital flows, considering the impact of various factors on the data.

The discrepancy between different sources of data have long led people to question the accuracy of official data.

For instance, while forex reserves fell by $125.2 billion in the first half of this year, Citigroup Global Markets Inc said that net capital outflows from China could reach between $281.7 billion and $286.6 billion during the time, according to an article published on the news portal wsj.com Friday.

"Capital outflows have been continuing at pace and they are a lot larger than what the authorities would have us believe through the official data," Sue Trinh, Hong Kong-based head of Asia FX strategy at the Royal Bank of Canada, was quoted as saying by Reuters on Friday.

But according to Zhou Yu, director of the Research Center of International Finance at the Shanghai Academy of Social Sciences, the discrepancy may be because of differences in the definitions of data sources.

"The forex reserves figure doesn't just represent capital outflows; it also includes inflows from trade surplus and foreign direct investment, for example," Zhou told the Global Times on Thursday. "If the two factors are stripped out, the reserves would have been lower."

In the first five months of this year, China's trade surplus reached 1.41 trillion yuan ($210.7 billion), according to the General Administration of Customs. The June trade data will not be released until Wednesday.

"Although the data might not give a clear picture, it all points to the same trend, and that's something we should look at," Zhou said.

Currency conundrum

It was not long ago that some experts warned that China's forex reserves may be too high, and the costs of accumulating foreign currency may outweigh the gains, according to media reports.

While China's reserves have declined steadily over the past two years from a peak of $3.99 trillion to the current $3.21 trillion, its hoard of foreign currency remains the largest in the world.

There seems little to be worried about, but investors and financial institutions don't think so.

"Three-point-two trillion of foreign currency reserves is large, in particular when China's external debt is relatively small," Diron said. "But one driver of the negative outlook on China's Aa3 rating is the risk that sustained capital outflows would pose difficult policy choices to the central bank, [which would have to choose] between preserving the value of the currency, preserving reserves and maintaining adequate liquidity."

In March, Moody's changed its outlook on China's government credit ratings to negative from stable.

"Sustained capital outflows would lead to a tightening in financing conditions and could signal lower confidence in the ability of the authorities to manage the transition in China's economy," she added.

For now, China's forex reserves have been regaining stability due to the weaker dollar over the past few months. But many are still concerned about potential outflow pressure.

Since late last year, policymakers have been using various measures to reduce the pressure of capital outflows on the country's forex reserves, including restricting forex purchasing and holding up high-profile overseas acquisition deals like the $9.3 billion buyout of Qihoo 360 Technology Co.

Moreover, recent media reports suggested that the government may soon draft rules to restrain capital outflows by imposing a so-called Tobin tax, a theory suggested by Nobel Prize winner and US economist James Tobin. The system would be imposed on international transactions and is designed to penalize short-term currency speculation.

"A Tobin tax is a tool that would reduce capital flows by increasing the trading costs for speculators," Zhou said.

"While capital controls have proved to be effective, they cannot be effective forever, and against a backdrop of the slowing economy and a quasi-fixed exchange rate, there is not much leeway left for China to adjust its policy," Zhou noted.

Continuing capital controls go against the country's promise of an open capital account, Zhou said.

Meanwhile, looser monetary policy would be helpful amid the economic slowdown, but it would also weigh down the yuan's value, leading to more capital outflows and further weakening of the currency, Zhou noted.

Editor: Chan

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