Jake's View

Forget the statements, China’s capital outflow is still enormous

The State Administration of Foreign Exchange says China’s capital outflow has ‘moderated a lot’, but calculating it the technical way shows a far different story

PUBLISHED : Sunday, 12 February, 2017, 2:36am
UPDATED : Sunday, 12 February, 2017, 2:36am

A statement from the State Administration of Foreign Exchange (SAFE) blamed seasonal factors for the larger than expected fall [in foreign reserves], including forex purchases for overseas travel and bond repayments.

“China’s capital outflow has moderated a lot and it will move towards a balance in the future,” it said. “The current reserves are adequate.”

SCMP, February 8

I shall accept that bit about the reserves being adequate but it doesn’t really mean much any longer. Adequacy of foreign reserves is an outdated concept from the days of the gold standard when countries worried themselves about how many months of imports they could pay for with their reserves if their export earnings collapsed.

The remedy these days is floating exchange rates and foreign borrowings. This is one of those rare instances in which human thinking has actually progressed. To put it in perspective, the United States, with a US$19 trillion economy, has foreign reserves of only US$117 billion while China, with a US$11 trillion economy has reserves of almost US$3 trillion, about 45 times as much relative to economic size and by far the world’s largest reserve hoard.

Yet it is China that obsesses about the adequacy of foreign reserves. You never hear of it in the US. But what is not true in the SAFE statement, is that China’s capital outflow has moderated. The chart sets out the facts. Capital outflow at the end of 2016 was still running at US$653 billion a year, only slightly less than a running figure of US$673 billion at the end of September.

This is not a moderate amount, nor has it “moderated a lot”. My authority here is SAFE itself, the government agency that calculates China’s balance of payments statistics and published the fourth quarter ones earlier this week.

The difficulty here is that most commentators on capital outflow, including SAFE officials, measure it only as how much the foreign reserves have declined over any given period. That would be US$12.3 billion over one month, US$122 billion over three months and US$232 billion over a year.

China’s forex reserves drop below US$3 trillion for first time in six years

It is not entirely an accurate measure as it ignores changes in the US dollar value of securities in other currencies but it does indeed represent capital outflow. People fleeing yuan have been given the US dollars they want from the foreign reserves, which are thus depleted. However, there is also another form of capital flight. It arises when exporters understate their true export income to Beijing and then keep the difference abroad. Alternatively they stint themselves on imports of raw materials and component goods, which also allows them to keep export earnings abroad. This is likely to be a good part of what produces a merchandise trade surplus now running at US$547 billion a year.

There are other tricks as well, such as declaring as tourist expenditure what is actually personal capital flight. It is what I think we largely have in SAFE’s reference to “larger than expected ... forex purchases for overseas travel.”

But we shall just do it the technical way. Non-reserve movements in the capital account on the balance of payments plus errors and omissions (which comprise little more than unreported capital movements) showed an outflow of US$187 billion in the fourth quarter last year and US$653 billion for the year overall.

That’s how you calculate a country’s capital flows and the calculation continues to show an enormous outflow.