CAPITAL outflows from China seem to be easing, but analysts say respite for the central bank may be short-lived as downward pressures on the yuan remain.
In February, for the first time in more than half a year, capital outflows showed some signs of stabilising. The gap between the onshore yuan and offshore in Hong Kong retracted, and in February and March net reserves fell by an estimated US$28.6 billion and US$35 billion respectively. That compares with US$100 billion previously.
This comes after repeated statements by China's central bank, the People's Bank of China (PBOC), and other government officials that the yuan will remain stable, with tougher controls on the capital account.
But analysts warn more devaluation pressures lie ahead for the yuan, with the currency expected to continue to fall against the US dollar (USD) this year.
Capital has been flowing out of China for the past two years, on the back of the crackdown on corruption and concern over the health of the economy. Companies have been paying back external debt while investors and the middle class seek to diversify assets. While this had been an ongoing trend, it accelerated sharply last year, with little inbound capital to offset outflows.
Last year, Bloomberg estimated that as much as US$1 trillion left China. China's huge foreign exchange reserves dropped by an estimated 500 billion to 650 billion yuan (S$103 billion to S$135 billion) in 2015 with monthly drops reaching 100 billion yuan throughout the end of the year.
Analysts warn pressures will continue for the next 18 months as China's new middle class continues to diversify assets out of yuan and companies seek opportunities outside of China's borders. "There is evidence outflows are slowing. We expect to see a structural change in the outflows over the next year. Less hot money outflows but increasing overseas direct investment. We expect a 5 per cent drop in the currency against the dollar," said Paul Mackel, head of forex research for HSBC.
HSBC expects reserves to fall an additional US$500 billion this year.
China has been pushing its companies to invest overseas to offload part of their overcapacities, acquire new technologies and develop new markets. Only last week, HNA, which owns Hainan Airlines, said it will buy Carlson Hotels, owner of the Radisson brand.
But analysts warn the central bank has in fact little leeway to fend off downward pressure on the currency and that its reserves are not infinite. It has to walk a fine line between supporting growth, implementing reforms and ensuring stability. It also has a long-term aim of internationalising the currency and making the exchange rate more market-driven.
The Federal Reserve is expected to raise its interest rates later this year which will further accentuate the USD-yuan gap.
"The PBOC is stuck," says Logan Wright, China markets research director with Rhodium Group.
"The concern here is that if the central bank keeps buying RMB (renminbi) and selling USD, foreign exchange reserves will fall too rapidly and it will be far more difficult to defend the value of the RMB.
"But there is also a concern tighter monetary policies would be bad for China. Basically they have to continue to intervene and accept the consequence (on) domestic policies or back away and see a sharp fall of the RMB."
The International Monetary Fund (IMF) has set a limit that China should hold as reserves at US$2.1 trillion. Under the current trend China could reach the threshold in less than three years. At this point, certain analysts anticipate the PBOC could unpeg the yuan completely and let the market determine the exchange rate.
"We think the reasons for capital account outflows will continue for another 12-18 months. The return on RMB assets will remain poor," says Amar Gill, head of Asia research for CLSA. CLSA expects the PBOC will unpeg the yuan at mid-2017, with the currency falling by 25 per cent.
This article was first published on May 2, 2016.
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