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China’s capital outflows set to grow in Q3 and accelerate further in 2017, analysts say

Pace of capital exodus likely to pick up in the current and coming quarters, putting further downward pressure on the yuan, analysts say

PUBLISHED : Wednesday, 26 October, 2016, 6:02pm
UPDATED : Wednesday, 26 October, 2016, 11:40pm

Capital outflows from China are expected to accelerate in coming months, adding further downward pressure on the value of the yuan, according to analysts who view Chinese authorities as prepared to let the currency weaken accordingly.

Capital outflows from China are expected to rise to US$113 billion in the third quarter of 2016, up from US$99 billion in the second quarter, Claudio Piron, emerging Asia foreign exchange strategist at Bank of America Merrill Lynch, said in a research note.

BAML estimates average outflows in 2017 rising to US$130 billion per quarter.

On the one hand, what BAML labelled “good” outflows, including overseas direct investment of Chinese companies and portfolio investment, are set to rise. The investment bank said that “bad” outflows, or the reduction in offshore yuan deposits by subsidiaries of Chinese banks, appear to be stabilising. Meanwhile, “ugly” outflows, namely net errors and omissions in trade and customs data, which represent illicit capital outflows, are undetectable and hard to predict.

“Capital outflows are here to stay,” Piron said. “We believe these outflows will be increasingly driven by overseas investment and liberalisation of portfolio investment.”

Strategic initiatives such as the “One Belt, One Road”, the new Silk Road, and the Asian infrastructure investment bank have opened new channels for infrastructure investment from China, according to Piron’s research.

Why China's 'One Belt One Road' Plan is Doomed to Fail

“We believe policy is supportive of the good capital outflows and the PBOC will allow the yuan to depreciate accordingly,” Piron said.

Based on its expectation of the pace of capital outflows next year, the exchange rate of the yuan against the US dollar is expected to weaken further to 7.25 by the end of 2017, BAML said.

“The next resistance for the yuan’s exchange rate against the US dollar is 6.8 as it is the level used to stabilise the economy in the immediate aftermath of the global financial crisis.”

Research by Mizuho Securities also points to accelerating capital outflows.

“Our estimates show that the pace of capital outflows may have been close to US$40 billion per month in the third quarter,” Shen Jianguang, chief Asia economist at Mizuho Securities Asia, said in a report.

“We note that from January to September, China’s foreign exchange reserves fell by US$164 billion, to US$3.166 trillion, the lowest level since May 2011, due to increased demand by investors looking to diversify their portfolios as the domestic housing market becomes overheated, prospects for a stronger US dollar, and on lingering uncertainty with regard to China’s underlying economic condition,” according to Shen.

Shen forecast the PBOC will support the yuan to prevent it weakening beyond 6.80 per US dollar at year end. Longer term the yuan is set for further devaluation, such that it should weaken to 7.3 per US dollar by the end of 2017, Shen said.

The PBOC set the daily reference rate for the yuan at 6.774 per US dollar on Tuesday, the weakest level in more than six years. Tuesday’s level represents a 1.42 per cent drop in the yuan since the end of September.

Meanwhile, offshore yuan in Hong Kong has been touching record lows, as Chinese policymakers set successively lower reference points to signal their willingness to allow for greater flexibility in the currency’s movement.

The performance has been in line with market expectation that Beijing will allow it to depreciate further after its inclusion as a member of the International Monetary Fund’s Special Drawing Rights basket.