China takes the middle road in managing its capital flows
For about six months from August of last year, the yuan was under heavy pressure with large amounts of capital flowing out of China. Local companies in China protected themselves by repaying foreign currency loans and investing in offshore assets, while n
Meanwhile, hedge funds sensed an opportunity and they too sold the Chinese currency.
All of this impacted Chinese foreign reserves which dropped to $3.2 trillion in February, well below their peak level of $4 trillion in June 2014.
Although $3.2 trillion is still an extremely high level of reserves, the rapid outflows of capital damaged confidence in China’s economy and raised the risk of a disorderly depreciation in the currency, which would hurt the country even further.
The Chinese government therefore took steps to strictly monitor fund movement and prevent unauthorised fund flows to support the yuan, which meant some businesses experienced greater difficulty in getting their money out of China.
Fortunately, the situation has stabilised since February. Fund outflows have reduced, the yuan has strengthened, and the outlook is now reasonably positive according to the Institute of International Finance (IIF), which predicts outflows will slow and inflows will turn positive for the second quarter of this year, supported by an increase in foreign direct investment, particularly in the services sector.
The IIF says one reason for the continued capital outflows is that Chinese businesses are diversifying their portfolios by investing offshore.
This is positive, not negative, and is being actively encouraged by the government in its “Going Out”policy.
Such outbound investment should support China’s prosperity and development.
However, there are still many risks. The US dollar, which has been weakening, could start to strengthen again and if it does there will be capital outflows not just from China but from all emerging countries, including Thailand.
Given the risk of volatility, I expect the need for stability is likely to take precedence over rapid financial market liberalisation. Companies doing business in China will therefore need to be patient, as it may take a while before the current restrictions are relaxed.
