China has seen nearly $1 trillion in capital leave the nation since the second quarter of 2014, and according to analysts at JPMorgan Chase, the sky's the limit for outflows going forward.
The causes of these massive capital outflows, which have prompted the People's Bank of China to tap the country's war chest of reserves to support the currency, have grown more numerous in the second half of 2015, argues a team led by managing director Nikolaos Panigirtzoglou. Amid the broadening of sources of downward pressure on the yuan, however, a major factor that may have restrained the central bank from devaluing the currency in a big way has vanished.
"The Chinese capital outflow picture appears to have entered a new phase in [the third quarter], broadening to include foreign direct investment and portfolio instruments, something that could make future capital outflows practically boundless," writes the JPM team.
Net foreign direct investment in China rose by $7 billion in the third quarter, its lowest level since 2000, with gross inflows falling precipitously compared with the second quarter. Meanwhile, foreign investors divested a net $17 billion worth of Chinese stocks and bonds over that same span.
The stock of foreign ownership of these two categories totals more than $3.6 trillion as of the third quarter of 2015, according to JPMorgan's calculations.
JPMorgan Chief China Economiost Zhu Haibin had previously observed that Chinese corporates' attempts to reduce U.S. dollar liabilities at a time in which softness in the yuan was in the offing was a major source of capital outflows. Foreign currency loans outstanding amounted to almost $400 billion at the end of the third quarter—on the face of it, there is plenty of room for Chinese firms to continue to dial down this exposure. But Chinese corporates have also been working to reduce asset-liability mismatches by piling up more foreign assets along with paying back foreign currency debt.
"While the accumulation of foreign currency or dollar deposits represents a capital outflow and thus puts downward pressure on the Chinese currency versus foreign currencies, it also increases the share of foreign currency debt that is hedged," JPM's team explains. "The implication is that, of the $387 billion stock of foreign currency loans, only a small portion is unhedged and thus vulnerable to further unwinding, especially after taking into account [the fourth quarter] which likely saw further progress towards hedging foreign currency debt."
If the depreciation of the yuan thus far has been limited by concerns that it would exacerbate Corporate China's balance sheet woes, then worries on this front ought to subside.
The upshot of this, according to JPM, is that "the low overall net foreign exchange exposure by Chinese corporates and banks removes one hurdle in terms of Chinese authorities allowing a larger and faster depreciation from here."
For the People's Bank of China, selling off some of its reserves is not a wholly negative event in and of itself. But as a sizable portion of this war chest could be earmarked for other purposes, Beijing's ability to defend its currency may be more limited than commonly appreciated, as Reuters’s Eric Burroughs notes.
"The Swiss cheese-like capital account and now onshore demand for dollars is putting pressure on foreign exchange reserves that make one think that this big insurance policy on future capital opening up may not be enough," he wrote. "Suddenly $1.8 trillion of reserves doesn’t sound like a lot in an economy still capable of seeing $150 billion or so of outflows in a given month and accounting for the usual import coverage needs."
On a day when interbank rates in Hong Kong spiked amid suspected support of the offshore yuan by Chinese policymakers, it's increasingly reasonable to question whether Beijing can manage its economic transition gracefully, or if unintended negative consequences stemming from policy errors will dominate the scene.