Chinese Capital Outflows Send FX Reserves To Lowest Since 2011
Overnight, China reported that the PBOC’s FX reserves fell another US$46bn to US$3.121 trillion in October as the central banks struggled to offset the impact of accelerating capital outflows, a bigger drop than the consensus estimate of US$34bn, triple the official September decline of US$19bn (recall that according to Goldman, the true FX outflow in recent months has been far greater), and the biggest drop since January. The October decline brought China’s total reserves the lowest amount since 2011.
As we have shown previously, a separate dataset called “PBOC’s FX position”, which shows the amount of PBOC’s FX assets at book value and is usually released around the middle of the month, should provide a cross-check on PBOC’s FX sales net of valuation effects.
As Bloomberg notes, the data come amid a period of renewed weakness for China’s currency. The yuan fell 1.53 percent last month, the most since a devaluation in August last year that shook investor confidence and ignited global market turmoil. Policy makers were suspected of propping up the exchange rate in the weeks leading up to a Group of 20 meeting in September and before the yuan’s entry into the International Monetary Fund’s reserves on Oct. 1 – and then reducing support after exports plunged the most in seven months. The currency fell to a six-year low of 6.7856 a dollar on Oct. 28.
The chart below which correlated China’s outflows with the value of the Yuan suggests that either the currency is temporarily undervalued, or that the real amount of Chinese reserves, which may be unreported by the PBOC to prevent an even greater retail outflow scramble, may be as much as half a trillion dollars less than what has been officially reported.
And with Chinese capital outflows speculated as soon becoming the biggest risk factor to global financial stability, in a repeat of late 2015, once the chaos surrounding the US presidential election is over, below are some economist reactions to the reported number:
- “The yuan was sprinting all the way to approach 6.8 in October, which may have prompted the PBOC to sell some reserves to stabilize the market,” said Gao Qi, a Singapore-based foreign-exchange strategist at Scotiabank. “Capital outflows will continue, the only questions is how fast, and that depends on the dollar’s move.”
- “Capital outflow pressures will be sustained at least for the coming months,” said Frederik Kunze, chief China economist at Norddeutsche Landesbank in Hanover, Germany. “Growing anxiety with regard to the soundness of the Chinese financial markets and the fear of a property bubble have to be seen in this context.”
- “The number indicates relatively light intervention by PBOC during the month,” said Ding Shuang, head of Greater China economic research at Standard Chartered Plc. in Hong Kong. Most of the drop comes from valuation effects, he said.
- Faster yuan depreciation against the dollar, higher interbank interest rates, and PBOC liquidity injections via open market operations “pointed to continued capital outflows in October,” said Robin Xing, an economist at Morgan Stanley in Hong Kong.
Should Clinton win tomorrow, and push the USD even higher on expectations of a December Fed rate hike, many strategists believe that the next stop for the Yuan will be to drop to a level somewhere in the vicinity of USDCNY 7.00.
And speaking of tomorrow’s election outcome, and how it may impact Chinese risk assets, here is Bank of America with how 4 distinct election scenarios can impact Chinese equities:
- Best scenario for China equities: Clinton win/split congress
If Hillary Clinton wins with a split Congress, we suggest buying short-duration HSCEI calls to position for a potential relief rally (likely to be brief); if it’s a Clinton sweep, buying environmental sectors and exporters, selling Rmb-sensitive sectors such as property, financials and commodities; if Donald Trump win/split Congress, buying One-Belt One-Road (OBOR) sectors, selling Chinese exporters to the US and Rmb-sensitive sectors; if a Trump sweep, buying HSCEI puts and domestic service sectors, selling environmental, Rmb-sensitive sectors and exporters in general; whoever wins, buying defense stocks as regional tension rises
- Polls say Clinton win/split Congress most likely
For more details, please see US Election: four scenarios, four lists by Savita Subramanian on Oct 28. This is arguably the best outcome for China equities in our view because the status quo may largely be maintained and the absence of a clean-sweep may mean only moderate upward pressure on USD. In addition, as the US election uncertainty is largely removed, risky assets, including China equities, may stage a relief rally.
- A Clinton sweep could hurt China equities
As David Woo argued, a clean sweep, either by Clinton or Trump, would be bullish for the USD. Such strength would come at a particularly sensitive time for Rmb devaluation expectations, thus, may trigger significant capital outflow from China and put significant pressure on Rmb, by our assessment. Separately, given the Democrats’ emphasis on environmental issues and the global nature of such issues, we expect related sectors in China to benefit as well.
- A Trump win/split Congress: impact on Rmb more uncertain
On the campaign trail, Trump wanted to label China as a currency manipulator & impose a 45% tariff on Chinese exports (Helen Qiao, Asia: trade tensions either way, Oct 24). This is behind our strategy-level call to sell Chinese exporters with heavy US exposure (Table 1, stocks with the highest US revenue ratio). To counter, China may speed up its OBOR program (One Belt & One Road, Great Expectations, 16 Mar, 2015). The impact on Rmb/USD rate is more uncertain – the Chinese govt may strengthen the soft peg to ease the trade tension or it may allow more flexibility on the exchange rate to stand up to the US or to reduce the chance of being labeled a manipulator. On balance, we think the latter is more likely due to the constraint imposed by capital outflow.
- A Trump sweep is the worst scenario for China stocks
In our view, a Trump sweep may mean a very strong USD, a much reduced risk appetite and a major sell-off of offshore China stocks by global investors. It could also blunt globalization as it loses its biggest champion, hence our selling of exporters broadly (Table 6 in our 2016 Year-Ahead lists the top exporters). If China’s growth turns inward, we expect domestically-oriented sectors, especially services, to benefit the most.