Macroscope | Beijing tightens capital controls to manage stability risk

Almost a month after the US presidential election, expectations of Trump policies have continued to rattle the global financial markets. In particular, they have caused wide-spread jitters across emerging markets (EM) via a stronger dollar and higher US interest rates. While Latin America has been hit the hardest, Asia also suffered from capital outflows and currency depreciation, with countries of weak external matrix (e.g. Malaysia and Indonesia) bearing the brunt of the shock.

The yuan has not been spared from this mini-rout. The onshore yuan rate shed 1.7 per cent in November, easing to 6.92 against versus the US dollar, a level that represents an eight-year low against the greenback. The offshore yuan rate went even further, easing to 6.95 per dollar before retracing to 6.89 per dollar recently.

The currency depreciation has mirrored an acceleration of capital outflows from China, with measures, using foreign exchange purchases by financial institutions, pointing to a monthly outflow of over US$60 billion between September and October. While they are still below the alarming levels seen at the start of the year, the pace of the capital exit has clearly stepped up a notch in recent months.

These outflows, however, have not caused any visible adverse impacts on the domestic market so far. First, the money market has remained broadly stable, thanks to the skillful operation of the PBOC to keep the system liquid. While short-term interest rates, such as the 7-day repo rate, have ticked up slightly, we know that it was partly driven by the authorities clamping down on shadow banking activity and reducing leverage in the bond market.

Second, large capital outflows are usually associated with declines in domestic asset prices, as foreigners repatriate capital and locals diversify investment overseas. Such is not evident in China either. Onshore equities, take the CSI 300 for example, have outperformed most other markets, gaining 8.5 per cent over the past two months. Property prices have also been resilient, despite the tightening measures instigated recently by local authorities. While the bond market has seen a sell-off of late, the rise in yields has been much more timid compared to that of the US Treasuries.

Third, large capital flight and currency depreciation are usually a precursor of financial crisis in emerging markets for countries that rely on external financing. This was true for the Latin American financial crisis in 1980s, and in Asia during the late 90’s crisis. However, China does not hold much external debt, which is less than 8 per cent of GDP. And for those do have it, many borrowers have been actively paying down their US dollar debt over the past 18 months following the yuan depreciation, and as onshore financing became cheaper and more accessible. With most of its debt denominated in yuan and held internally, China does not face a great risk of a classic emerging market debt crisis.