Funny Numbers Show Money Leaving China
News that China's foreign-exchange reserves rose by $10 billion in March rather than declining has quieted doomsayers. Worries that the reserves could dip to dangerous levels as soon as this summer -- after shrinking by an estimated $1 trillion last year -- appear to have been premature. Still, questions linger over exactly how much money is leaving China and why. The true picture may not be as rosy as the headline numbers suggest.
Before the March upturn, capital had been flooding out of China at a rapid clip -- an average of $48 billion per month over the previous six months, according to official bank data. The reasons were several. Fearing further declines in the value of the yuan, several companies paid off their dollar loans; others pursued big acquisitions abroad. Individual investors sought out higher returns as the Fed prepared to raise rates. The government spent billions to prop up the value of the currency. Some individuals and companies reduced their offshore yuan deposits. Still others looked to spirit money out of the country to safer havens.
The question is how much money has been leaving for which reasons. Some analysts, including economists at the Bank for International Settlements, have argued that the bulk of these outflows are healthy, mostly involving companies paying down their foreign debt. However, the BIS study, which estimates that such repayments accounted for nearly a quarter of the $163 billion of non-reserve outflows in the third quarter of 2015, focuses on a very narrow slice of time. Foreign debt obligations grew rapidly in late 2014 and the first half of 2015, then shrunk dramatically in the third quarter.
Moreover, what those official figures miss are hidden outflows, disguised primarily as payments for imports, which appear to have created a $71 billion current account deficit in the same quarter, according to bank payments data. In effect, enterprising Chinese are overpaying massively for the products they're importing. Chinese customs officials reported $1.68 trillion in imports last year. Banks, on the other hand, claimed to have paid $2.2 trillion for those same imports. While the official balance-of-payments records a current account surplus of $331 billion in 2015, banks' payments and receipts show a $122 billion deficit.
Overpaying for imported goods and services is a clever way for Chinese companies and citizens to move money out of the country surreptitiously. Let's say a foreign country exports $1 million worth of goods to China. Chinese customs officials will faithfully record $1 million in imports. But when the importer goes to the bank, he'll either use fraudulent documentation or bribe a bank official to record a $2 million payment to the foreign counterparty. Presumably, the excess $1 million ends up in a private bank account. While some discrepancies are to be expected in data like this, the size and steady increase in the gap since 2012 implies that something shadier is going on.
When Chinese companies pay down debt, or make big acquisitions abroad, they do so openly. These other outflows -- which topped half a trillion dollars last year -- seem far more likely to be driven by individuals and companies simply seeking to get their money out of the country.
The timing is also telling. The discrepancy began to grow rapidly in 2012, just as growth peaked and concerns began to rise among affluent Chinese about the economy and a political transition. Since then, fake import payments have grown from $140 billion to $524 billion in 2015.
During that period, growth in China has slowed, rates of return on investment have declined and surplus capacity has exploded. Investment opportunities have shrunk, while state-owned enterprises have crowded out private investors. Certainly the latter have good reason to seek better returns elsewhere.
At the same time, President Xi Jinping's anti-corruption drive has netted tens of thousands of Party officials. Naturally, well-to-do Chinese are worried about being caught up in the dragnet even if innocent. They're also just as concerned as anyone else about their children's education and health. The demand for real estate abroad -- according to one study, two-thirds of high-priced home sales in Vancouver involve Chinese buyers -- is only going to grow.
Scrutinizing bank payments more closely and tightening capital controls would help slow down outflows. But just as businessmen discovered this new channel to move money offshore, they're almost certain to find creative ways around any additional limits that are imposed.
The Chinese economy is groaning under massive overcapacity, with growth slowing and financial risks rising. Neither a cut in interest rates nor another stimulus package is going to relieve that long-term pessimism. Reform -- including legal reform -- may. If China's leaders want to prevent capital from leaving the country, they're going to have to address the reasons for the flight, not just erect roadblocks in its way.
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