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China’s capital outflows ‘remain persistent’ despite regulatory scrutiny of corporate deals

PUBLISHED : Monday, 24 July, 2017, 4:09pm
UPDATED : Monday, 24 July, 2017, 10:30pm

Capital outflows from China “remain persistent” as Chinese companies and households boost their holdings of foreign currency deposits and increase outbound direct investments, despite ongoing regulatory scrutiny of Chinese firms’ foreign acquisitions, analysts say.

China’s balance of payments, the most comprehensive source of data on capital flows, shows outflows of US$21 billion in the first quarter, down from US$161 billion in the fourth quarter of last year, according to recent government statistics. Second quarter figures will only be published next month.

“While outflows have declined markedly since late last year, they remain persistent,” Julian Evans-Pritchard, China economist for Capital Economics, said in a recent research note.

“China’s growing appetite for foreign assets means that outflows are likely to persist.”

Pritchard estimated that outflows amounted to US$27 billion in June, slightly down from May’s US$29 billion.

Zhang Ming, chief economist for Ping An Securities, said that although capital outflows through legitimate channels have fallen this year, “illicit outflows remain significant”.

The “net errors and omissions” in the balance of payments, widely regarded as an indication of underground capital activity, pointed to a net outflow of US$57.7 billion in the first quarter.

Analysts said outflows persist as Chinese companies and households continue to add to their holdings of foreign currency deposits and foreign securities.

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“This is part of a long-running structural shift, with China’s private sector seeking to diversify by increasing its exposure to foreign assets,” said Evans-Pritchard.

Meanwhile, the pace of outbound direct investment remains rapid and picked up in June, even in the midst of ongoing regulatory scrutiny over Chinese firms’ foreign acquisitions.

“This partly reflects increasing investment in the Belt and Road countries,” said Evans-Pritchard.

“China’s regional initiative, along with the boost to trade finance from the pick-up in global trade, has led to rapid external lending by Chinese banks.”

Other factors include expectations of a stronger US dollar as the Federal Reserve looks likely to unwind its gigantic balance sheet later this year, a slowdown in the Chinese economy, and a potential fall in China’s money market rates, Zhang added.

Zhang expects the outflow pressure to worsen in the second half of this year as the yuan could reverse course and weaken against the greenback if the Fed reduces its balance sheet as expected, while Chinese economic growth looks likely to slow down further.

China’s regional initiative, along with the boost to trade finance from the pick-up in global trade, has led to rapid external lending by Chinese banks
Julian Evans-Pritchard, Capital Economics

Evans-Pritchard said there is little reason to expect the outflows to stop in future. However, he added that the outflow pressure should be manageable unless sentiment on the yuan turns “significantly more negative”.

“At their current pace, [capital outflows] aren’t putting much pressure on the People’s Bank of China’s reserves since they are largely offset by China’s current account surplus,” he said.

Separately, both analysts noticed a phenomenon where foreign investors have increased their holdings of renminbi bonds in the past few quarters.

Foreign investors appear “fairly upbeat” on Chinese assets and continue to add to their holdings of renminbi assets, thanks to strong earnings, higher yields, and an easing of yuan depreciation expectations, Evans-Pritchard said.

Zhang added that another major reason is that the Chinese government has significantly loosened curbs on foreign investments of Chinese bonds.

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In June, inflows into onshore bonds jumped following the launch of Bond Connect, a mechanism that allows foreign investors to directly access the Chinese onshore debt market.

According to official statistics, overseas institutions boosted their holdings of renminbi bonds by 36.13 billion yuan (US$5.3 billion) in June, the biggest monthly increase this year. It also marked the fourth straight month of rise.

Among all types of bonds, holdings of rate securities increased the most, up 30.5 billion yuan for the month.

Other than bonds, inbound direct investment flows have also edged up recently.

Foreign direct investment (FDI) rose 2.3 per cent year-on-year in June to 100.45 billion yuan, the first increase in three months, according to data from the Ministry of Commerce.

The ministry said FDI in high-tech service sectors jumped 11 per cent year-on-year during the first half.

Among them, information services, R&D (research and development) and design services, and commercialisation of research grew by 35.6 per cent, 13.9 per cent and 46.3 per cent respectively from the same period a year ago.

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