From the balance of payment perspective
Despite a larger-than-expected amount of net exports this year, China’s capital accounts have printed negative numbers for several months, while in the past China always reported surpluses in both current account and capital account. Some analysts start arguing that China is facing tremendous amount of capital outflow implying that many people are losing confidence on China’s economy. Moreover, they say, Renminbi depreciation in the first three quarters support the view that capital is flowing out of China. Acknowledging capital flight a very important issue, we at the central banking seminar made an effort to find out the reasons for the Renminbi depreciation and the capital account deficit.
Triggered by the worseness of the European debt crisis and concerns about China’s hard-landing, the Renminbi exchange rate has reversed from appreciation to depreciation in the domestic market for 12 months since September last year. As our last blog entry on China’s FX Flow Framework discussed, Chinese importers and exporters started to go long USD and short RMB, which affects the capital flow and capital account.
As China's recent international balance of payments suggested that there is $56.1 billion capital account deficit from 2012Q1-Q3, subtracted $127.2 billion FDI, the remaining $183.3 billion should be the capital flowing out of China. However, instead of proposing so-called capital flight for this $183.3 billion, we argue that Chinese importers and exporters’ foreign exchange position plays a dominate role in this capital flow fluctuation.
So, the question is how importers/exporters’ FX position affect the capital flow and, more importantly, how large their influence is. Here we try to explore these questions from two angles: one is the FX flow from current account activities; the other is correspondent capital account, which approximately tracks the real capital movement.
From our previous discussion and analysis (see previous blog entry), we used to introduce three sets of data: trade account balance for goods, cross-border receipt/payment balance for goods, and banks’ FX selling/buying balance for goods to track FX flow. From the chart 1 we can see that the relative position of the three sets of data reversed the trend from September 2011, matching the Renminbi expectation change from appreciation to depreciation.
And if we further compare the change of relative position of either of the two lines, we detect that two vital drivers of the capital outflow resulted from importers/exporters’ speculation activities: when Renminbi is expected to depreciate, domestic importers tend to advance payment of USD, given the trade is settled in USD, reflecting on the foreign exchange settlement between importers and banks. Moreover, domestic exporters who receive the dollars from exports are inclined to hold USD asset rather than exchange it to RMB, reflecting on the foreign exchange settlement between exporters and banks. Through our analysis, these two drivers play a vital role in capital outflow.
Chart 2 shows the first driver: the difference between cross-border receipt/payment balance and trade balance, measuring advance or delayed payments of goods from both domestic and foreign companies. Before September 2011, monthly net receipt was usually larger than monthly net exports, as Chinese importers always delayed payments so that they could gain from Renminbi appreciation for a few more months before converting it to US dollar.
After September 2011, however, monthly net receipt became less than net exports as Chinese importers speeded up the dollar payments and they even paid in advance as they no longer expected Renminbi to appreciate.
From the Chart 1, we can also see that while net export remains quite strong this year, net receipt is comparatively weak, illustrating importer’s strong willingness to purchase USD from banks through advancing payment of the trades. Moreover, if we added up this difference from Q1-Q3 2012, approximately we get a negative 62 billion in total after adjustment (the February number is an outlier due to seasonal factors). The 62 billion should be related to a large amount of trade credits and thus contributing to capital outflow from capital account’s perspective.
Not surprisingly, trade credits account shows a huge increase in international balance of payments, as is shown in table 1. In the first 6 months, it totaled 33.2 billion and it is expected to be larger in Q3.
Chart 3 shows the second driver: the difference between cross-border receipt/payment balance and banks’ net FX purchase balance, measuring Chinese companies’ net FX funding from domestic banks. This number usually stayed negative before October 2011, which means that Chinese companies sold more dollars to the banks than they received from international trades.
How could they consistently sell more dollar than they receive from trades? The Sources & Uses of Funds of Financial Institutions (in Foreign Currency) by the PBOC shows that foreign currency loans kept increasing much faster than foreign currency deposits in the past few years (see Chart 4).
The data suggests that in aggregate Chinese importers/exporters were borrowing dollar from banks and converted them to Renminbi. However, this long-lasted trend reversed in October 2011. The difference turned from large negative to slight positive. As Chinese companies reduced dollar liabilities and increased dollar assets, which resulted in a rise of outflow in the capital account.
As is shown in the capital account, currency and deposit account item reported -96.7 billion in the first 6 months this year, almost doubling the number in the same period of last year. The preliminary data from SAFE showed a large capital account deficit and a rise in FDI in the third quarter, again suggesting a large outflow from “other investments” in which trade credit, loans, and deposits accounted a dominant share.
Taking all into account, we believe the FX position change of Chinese companies was mainly responsible for the capital account deficit, which was not really any sign of losing confidence in Chinese economy.
We agree with the SAFE that capital account deficits should not be regarded as capital flight. Remember that the sum of current account, capital account, and foreign reserves must equal to zero, and every dollar flowing in must flow out. In the past, both current account and capital account reported surplus, and dollars mainly flowed out from the government channel as the SAFE invested the foreign reserves into foreign assets in which US treasuries account for a large share.
However, the mandatory sale of foreign exchange has already been deregulated in August 2007 and domestic companies and households can hold foreign currency as they want. Therefore, dollars can flow out from private channels which would result in a capital account deficit. It did not happen until last year because Chinese growth was rapid and Renminbi appreciation expectation was extremely strong before October 2011.
By the end of June, China has $1.7 trillion net FX assets but the distribution is very imbalanced. The government has $3.3 trillion foreign reserve and the non-government sector has $1.6 trillion of net FX liabilities.
Although the Renminbi depreciation trend seemed to have ended since October, we believe that this currency mismatch of government and private balance sheets is almost certainly to reverse again in the future, which will lead to larger capital account deficits and Renminbi depreciation pressure.
More importantly, if private sector prefers holding foreign assets rather than selling to the banks, this preference will undermine the PBOC's ability to create Renminbi liquidity. We saw that outcome earlier this year as many commercial banks were extremely hungry for deposits.
Table 1: International Balance of Payments
Central Banking Seminar
Tan Shibo and Chen Long