People's Republic of China: Selected Issues
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
12 Aug 2016
eISBN:
9781475524383
Language:
English
Keywords:
ISCR; CR; China; IMF staff estimate; GDP; market; net capital outflow; China's capital account; capital account deterioration; foreign exchange; Capital account; Foreign direct investment; Foreign liabilities; Global; China's acquisition
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The People's Republic of China: Selected Issues

Abstract

The People's Republic of China: Selected Issues

China: Outlook for Net Capital Flows1

  • In recent years, China's capital account saw a rapid acceleration in external borrowing.

  • In 2014, that borrowing peaked before becoming large relative to standard metrics.

  • Unwinding these liabilities has been a key driver of outflows and is almost complete.

  • Nonetheless, risks persist with respect to FDI and Chinese savers’ home bias.

1. In 2015, China experienced unprecedented net capital outflows of 6.2 percent of GDP (US$ 673 billion). This is only the second time since 2000 that China has experienced net capital outflows. Such large outflows are important in their own right: when large, sudden or sustained, they can cause financial stress and output losses. They are also important for what they represent: such material changes in investor sentiment occur as a result of a change in some underlying fundamental such as an emerging policy inconsistency or change in expectations. This note looks at the nature of recent capital flows to better understand their durability going forward.2

2. Over the last two decades, gross capital flows have grown materially. The pattern of those flows is a function of both the relative pace of growth between China and the rest of the world and the pattern of capital account liberalization. That is, China's acquisition of foreign liabilities (inflows) has grown far faster than foreign assets (outflows) because investors sought to take advantage of China's rapid economic growth and residents were limited in their ability to diversify abroad. The large inflows were initially dominated by equity in the form of FDI. But on the eve of the global financial crisis, China began to liberalize the acquisition of external debt, leading to a sharp increase in external borrowing. In the four years since 2008, foreign loans and nonresident deposits alone rose from 200 billion a peak of 1.1 trillion, roughly 10 percent of GDP.

Figure 1.
Figure 1.

International Investment Position

(In billion of US dollars)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.
Figure 2.
Figure 2.

Foreign Liabilities

(In billion of US dollars)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.

3. Indeed, in a de facto sense, China's capital account has not looked particularly closed. There is no question that controls still exist in China. Relatively constant onshore-offshore gaps exist for key prices, approval requirements remain for direct investment, and the portfolio account is still subject to strict quotas. But when looking at gross capital flows scaled by GDP, China is consistent with other large emerging markets and, in terms of stocks, China materially trails advanced markets but is broadly in line with most emerging markets. In short, controls matter but have still allowed material flows.

Figure 3.
Figure 3.

Gross Capital Flows

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.
Figure 4.
Figure 4.

Private Foreign Assets and Liabilities

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.

4. The most recent bout of outflows started in early 2014 and reflected both the repayment of foreign liabilities and the acquisition of foreign assets. But while the pace of repayment of foreign liabilities by residents (or nonrollover by nonresidents) has accelerated almost every quarter, there was a step increase in foreign asset acquisition that has remained relatively constant since.

Figure 5.
Figure 5.

Net Capital Outflows (Adjusted)

(In billion of US dollars)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.
Figure 6.
Figure 6.

Capital Account (Adjusted)

(In billion of US dollars)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.

5. One can see this in greater detail by looking at a table decomposing the change in flows. On an annual basis, the increased pace of foreign asset acquisition, mainly "Other Investment" abroad, explains about 70 percent of the deterioration in the capital account in 2014 but only roughly 15 percent in 2015. That is, in the past year, a more rapid reduction of nonresident claims on China has been by far the dominant driver of outflows.

Table 1

Decomposition of Capital Account Deterioration

(In billions of U.S. dollars)

article image
Source: CEIC Data Company Ltd.; and IMF staff estimates.1/ Changes exclude "Other Investment: Asset: Other Receivables," which is largely driven by policy changes that resemble intervention.

6. The rapid reversal in foreign liabilities is driven by the change in appeal of the carry trade. Indeed, the dynamics of foreign liabilities are driven by the loans and deposits part of Other Investment, two relatively open parts of the capital account in which the carry trade was played. In turn, the reversal tracks the expected return as measured by the interest differential and the forward points.

Figure 7.
Figure 7.

Net Acquisition of Liabilities

(In billion of US dollars)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.
Figure 8.
Figure 8.

Foreign Exchange Carry

(Expected 12 month return)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.

7. The drivers of the step up in the pace of foreign asset acquisition are more complicated. Historically, the dynamics of Chinese foreign asset purchases were driven by loans and deposits in Other Investment, much like with liabilities. However, since early 2014, this relationship broke down due to a surge in overseas direct investment (ODI) and errors.3

Figure 9.
Figure 9.

Net Acqusition of Foreign Assets

(In billion of US dollars)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.
Figure 10.
Figure 10.

Net Acqusition of Foreign Assets - Select Items

(In billion of US dollars)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.

8. Both the rise in ODI and errors and omissions appear to reflect, in part, changes in short-term sentiment. On ODI, the increase in outflows likely reflects, in part, the traditional desire for new markets and technology as GDP growth in China moderates. However, the sharp rise in intra-company loans at precisely the same time as the increase in capital flight elsewhere in the BOP is suggestive of firms using the relatively low capital account restrictions in direct investment to reduce net exposure to Chinese assets. Meanwhile, the pattern of increase in errors and omissions is suggestive of similar factors. In China, discrepancies between customs data on trade and SAFE data on foreign exchange demand related to export transactions tend to show up in errors and omissions. During the recent period, one can see a sharp rise in these discrepancies. The fact that the decline of export receipts conversion into renminbi has outpaced the decline of exports measured by customs data likely reflects the increasing desire of domestic enterprises to hold foreign exchange deposits due to depreciation expectations.4

Figure 11.
Figure 11.

Overseas Direct Investment

(In billion of US dollars)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Source: CEIC Data Company Ltd.
Figure 12.
Figure 12.

Exports and Foreign Exchange Demand

(In billion of U.S. dollars, 12mma)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Source: CEIC Data Company Ltd.

9. Going forward, one can expect a deceleration in outflows related to external debt repayment. The key categories that drove the rise in external debt have returned to levels last seen before the carry trade really accelerated in 2011–12. Overall external debt is now quite low at 12 percent of GDP, particularly compared to past crisis cases. One would not expect external debt to fall to zero as some of the financing reflects underlying economic transactions not sensitive to changes in short-term expectations. The expected slowing of external debt repayment could reduce outflow pressure by $100–125 billion per quarter.

Figure 13.
Figure 13.

External Debt

(In billion of US dollars)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Sources: CEIC Data Company Ltd.; and IMF staff estimates.
Figure 14.
Figure 14.

External Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 271; 10.5089/9781475524383.002.A004

Source: World Economic Outlook (WEO).

10. Nonetheless, there are still two primary risks to the capital account. First, there is a question as to what happens to the flow and stock of China's foreign direct investment. In terms of the flow, China's slowing growth prospects may weigh on inward FDI in a way that helps offset the improvement from lower debt payment; lower inflows, in an accounting sense, are the same as a rise in outflows. In terms of the stock, firms’ accumulated reinvested earnings, to the degree they are in liquid assets, could leave as dividends which are current account transactions that do not face capital controls. Second, there is a question as to the speed at which Chinese investors will choose to acquire foreign assets and normalize what has long been seen as an excessive home bias. Nonreserve foreign assets remain low in China relative to investable private savings. For now, staff's judgment is that the combination of a rising current account surplus, low external debt, large reserves, and a still relatively controlled capital account should support a stabilization of outflows.

1

These summary notes provide background documentation for the 2016 Article IV consultation with China. Many are based on longer research papers that are expected to be published over the next few months.

1

Prepared by Geoff Gottlieb (SPR).

2

In this note, the focus is on capital outflows recorded in the capital account and errors and omissions. There has been some discussion of whether there is also capital flight in the current account, notably with reference to tourism. However, this is difficult to verify due to important changes in SAFE's statistical methodology in 2014-15.

3

When analyzing private capital flows, the line item "Other Investment: Other Receivables" is excluded as it relates to changes in Other Foreign Assets on the balance sheet of the PBC and tends to be policy driven. This line item included an US$ 87bn inflow in Q3:2015.

4

Note that such discrepancies between customs trade data and SAFE's foreign exchange data do not imply per se that the current account surplus is overstated. Rather, they point to outflows conducted by exporters and importers that are already captured in the capital account and errors and omissions.

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
The People's Republic of China: Selected Issues
Author: International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2016: Issue 271
Publisher:
International Monetary Fund
ISBN:
9781475524383
ISSN:
1934-7685
Pages:
50
DOI:
https://doi.org/10.5089/9781475524383.002

International Investment Position

(In billion of US dollars)

Foreign Liabilities

(In billion of US dollars)

Gross Capital Flows

(In percent of GDP)

Private Foreign Assets and Liabilities

(In percent of GDP)

Net Capital Outflows (Adjusted)

(In billion of US dollars)

Capital Account (Adjusted)

(In billion of US dollars)

Net Acquisition of Liabilities

(In billion of US dollars)

Foreign Exchange Carry

(Expected 12 month return)

Net Acqusition of Foreign Assets

(In billion of US dollars)

Net Acqusition of Foreign Assets - Select Items

(In billion of US dollars)

Overseas Direct Investment

(In billion of US dollars)

Exports and Foreign Exchange Demand

(In billion of U.S. dollars, 12mma)

External Debt

(In billion of US dollars)

External Debt

(In percent of GDP)