From BNP Paribas’ Richard Iley (with our emphasis):
The release of preliminary data on China’s Q1 balance of payments, while incomplete, nonetheless furnishes us with the hardest evidence yet of the alarming scale of hot money outflows from the mainland. By construction, the change in foreign assets (FX reserves) is the sum of the basic balance (current account + net foreign direct investment) + net hot money flows (basically bond and equity investments + bank lending) + ‘errors and omissions’. The latter works as a balancing item and so reflects hot money flows not captured in recorded flows.
Full detail of the Q1 data is not yet available but China enjoyed a bumper basic balance surplus of $129.2bn (current account surplus $78.9bn; net FDI inflows of $50.2bn) even as official reserve assets fell by $80.2bn. With total capital account in deficit to the tune of $78.9bn i.e. net outflows, recorded hot money outflows were also -$129.2, leaving a huge ‘errors and omissions’ balancing item of -$80.2bn in the first quarter. This is easily a record deficit for the balancing item and necessarily implies accelerating unrecorded hot money outflows. On an annualised basis, ‘errors and omissions’ were worth just over $320bn which equates to a record 3.5% of GDP. Over the past year, ‘errors and omissions’ have totalled $244bn.
Adding the ‘errors and omissions’ deficit to recorded net hot money outflows gives an aggregate estimate of overall hot outflows or capital flight from the mainland. By construction, this slumped to a record $209.5bn ($838bn annualised) or an eye-watering 9¼% of GDP (Chart 2). Overall, in the year to Q1, China has seen capital flight of $584bn or 5.6% of GDP.
They are estimates obviously, but still, those are big numbers. And, while it’s probably true the PBoC is reasonably chilled so far, this is another clear and ongoing reason for its defensive easing policies. Polices which Tyler Cowen describes (when writing how to think about China’s third interest rate cut in six months, which happened over the weekend for those not paying attention) partly in terms of an Austro-Chinese model:
In an Austro-Chinese, excess capacity model of the business cycle, there is a gain and a loss from cutting interest rates when an economy is well into the over-expansion phase. The gain is that you may mitigate the costs of the “secondary deflation,” as the Austrians call it. The cost is that you may overextend the excess capacity even further. That is a call the central bank must make, noting that the excess capacity model applies only with some probability.
The hot money outflow issue is also a very good reason to not expect depreciation of the CNY as a response to so-called currency wars and stalling exports — along with China’s wooing of reserve currency status which will see it, notes Seb Galy, adopt IMF norms and give us some actual reserve composition data in the future.
Validation of depreciation expectations would risk further accelerating bets on yet more weakness and leave the central bank chasing its tail. Any modest tinkering such as further widening of the CNY’s daily trading band from its current +/-2% will be delayed until the PBoC has more decisively stared down depreciation speculation. In the short-term that leaves China unable to fight back in the currency wars and having to ‘wear’ the biggest competitiveness shock to the economy since the Asia crisis, which, as we predicted, is pushing export growth close to zero so far this year.
And from Iley again on what’s to come next:
Without an unlikely rapid tailing off of capital outflows, the authorities therefore look to have little choice but to press on with more RRR cuts to reverse the de facto sterilisation of prior FX reserve accumulation and also to accelerate the backdoor QE* that the PBoC quietly started last year. Via increased claims to depository institutions under its Pledged Supplementary Scheme (PSL), PBoC’s domestic assets have already increased by around 2½% of GDP over the last year. Although the biggest increase in a decade, this only offsets about 2/3rds of the drain on the monetary base from falling foreign assets… More is clearly required with outright purchases of, or the acceptance as collateral, of local government debt an obvious candidate to further boost the balance sheet.