Who's behind the exodus of capital from China? In popular imagination, it's foreign hedge funds and other investors dumping Chinese assets that caused $1 trillion of wealth to stampede out of the mainland in 2015. But a new analysis by the Bank for International Settlements points the needle of suspicion toward a more prosaic actor: the little fellow in Hong Kong, Macau, Singapore, Seoul and Taipei who's suddenly scared to park money in a yuan deposit in his neighborhood bank.
The BIS study shows how a $40 billion withdrawal of offshore renminbi deposits in just these five locations during the third quarter of last year, presumably following the Chinese central bank's nerve-rattling Aug. 11 devaluation, may have triggered twice as big a reduction in these and other overseas banks' own claims on mainland lenders. That's $80 billion gone from China in just three months, amounting to almost half the $163 billion that moved out of the People's Republic in cross-border transactions. (The People's Bank shifted a further $12 billion of its reserves to banks outside China, taking the total outflows during the quarter to $175 billion.)
Now take the $41 billion in foreign-currency debt repayment by Chinese companies to banks overseas and at home, and add it to the $80 billion figure. The role of investors selling down yuan assets shrinks to a quarter of the total outflows.
Clearly, foreign depositors -- and not investors -- are driving the capital flight from China. This has three implications. One, the Chinese authorities encouraged the offshore yuan market to promote the use of yuan in global commerce even though it wasn't fully convertible. It all went swimmingly as long as depositors overseas were lured by the prospect of never-ending yuan appreciation against the U.S. dollar. That unspoken assumption is now broken. If the authorities in Beijing chase a rising dollar amid a slowing domestic economy, they would invite Japanese-style deflation, an unacceptable risk given the high level of corporate debt.
Two, a strike by offshore depositors can be self-fulfilling. As offshore banks move money out of China to meet their commitments to depositors overseas, the yuan could weaken further, reducing what is already a low rate of return on capital for foreign equity investors. In a wobbly stock market, that could prompt further selling. That at least partly explains why China might delay a plan to liberalize its tightly controlled market for initial public offerings, lest it give investors another avenue to exit inefficient state-owned enterprises in favor of better-run private companies.
Finally, pump-priming could backfire. The budget deficit target of 3 percent of GDP for this year, released on the opening day of the national legislature's much-awaited annual session, is an increase from 2.3 percent in 2015. While the expansion may be welcome, with both fiscal and monetary policy loosening to revive growth, a bigger deficit could put the yuan under renewed downward pressure in the short run. That might further deter overseas savers.
Investor skepticism toward China's reforms is a potential threat to the currency, but it's not the only one. Given their propensity for herd-like behavior, a loss of faith among offshore depositors could be an even bigger problem.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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