Yuan devaluation fears deserve more credence

The mainland devaluation rumour has surfaced again but this time with a little more substance to the argument than earlier.

Some commentators are now making the case that capital outflow from the mainland is rising fast and, even with an almost record trade surplus, this could push the balance of payments into deficit next year, which would undoubtedly put the currency under some strain.

They say it is happening because foreign banks are pulling out money as a result of a corporate debt crisis brought on by the financial troubles of the international trust and investment corporations (Itics).

The key measure the commentators look at is the mainland's foreign reserves which, as the first chart shows, have remained virtually static since late 1997 despite the upward push they should have had from the trade surplus. It implies the money is pouring out as rapidly through one spigot as it is pouring in through another.

But first a word of warning. The data is uncertain. The mainland has published its balance of payments only up to the end of 1997 and, without full figures, it's a long jump from trade surpluses and reserve movements to conclude that foreign banks are now running for the exits.

For one thing, the 1997 data already indicates that a good portion of this supposed capital outflow is no such thing. It is actually income debit, a current account item, and it comes mostly from interest payments on foreign debt. This amounted to an outflow of US$19 billion and was equivalent to 41 per cent of the trade surplus.

For another there was a huge negative gap of $17 billion in the balance of payments data under the heading 'Errors and Omissions'. This is an economist's way of saying that the figures don't add up and can't be made to do so. It could make the real capital outflow greater than the stated figures. It could also fit somewhere else in the data. No-one knows for sure.

But as an exercise, let's assume that all the figures we do not yet have for last year were the same as in 1997 and that changes in the final balance of payments figures perfectly reflect changes in the level of foreign reserves (they don't always do so). What then happened in the capital account last year? The answer is in the second chart. It says that net capital flows have gone from a $40b surplus in 1996 to a $6 billion deficit last year. It says the overall balance of payments went from a $35.7 billion surplus in 1997 to $4.5 last year.

Whether this was the result of the mainland investing more money abroad, foreigners investing less money in the mainland or foreigners pulling money out the figures do not say, even for 1997. That level of detail is not published.

So the pessimists may prove to be right about why it happened although the one thing they do not yet have is proof. Intuitively it seems unlikely that the Itic troubles could already have driven such a hole through last year's figures when they only surfaced near the year's end.

But the figures do clearly suggest that the mainland faces some questions of investment confidence.