At the beginning of the year, the entire financial world was obsessed with China, or more specifically, Chinese capital outflows. Betting against China became the #1 hot trade of 2016 during the first quarter. Wall Street analysts claimed that China would not be able to stop the tidal wave of capital leaving the country, which would force policymakers to abandon currency controls, letting the yuan collapse along with China’s financial system.
Read Bert Dohmen: China Still the Greatest Threat to Global Markets
As we move into the fourth quarter, it’s clear that the financial apocalypse has not arrived in Asia. Capital outflows have calmed since the beginning of the year and are now, according to Societe Generale’s China analyst Wei Yao, “tamed”.
China Has Tamed Its Currency
According to Yao, it would appear that the People’s Bank of China has brought the foreign exchange market to heel since the beginning of the year when FX reserves were falling by around $100 billion per month. In a research note on China sent to clients at the end of last week, Yao writes that since March the pace of FX declines at the central bank have stabilized at around $10 billion per month after adjusting for valuation changes. Even if you question the reliability of this data, other capital data flows suggest easing outflow pressure. Overall net FX sales of banks – the main cause for declines in official FX reserves – eased to $9.5 billion in August from $31.7 billion in July, resuming the improving trend started in April. Meanwhile, net cross-border receipts by banks on behalf of clients – a proxy for the BoP balance of the nonbank sector – have improved since February, averaging around -$20 billion per month. Finally, the $30 billion pickup in FX loans in August likely suggested the end of FX debt deleveraging of China’s corporate sector, which would remove a big source of outflow pressure going forward.
Yao writes that the improving FX environment gives the PBoC more scope to conduct monetary policy easing domestically, without upsetting the markets. The bank has been using this extra freedom to expand into domestic assets, offsetting declines in its foreign assets. At the same time, the bank is targeting a level of short-term interbank rates and it is providing liquidity according. Standing loan facilities have been introduced to give the PBoC much more flexibility in liquidity management. It can now address liquidity tensions with more precision and in a more timely fashion, and it does not have to resort to RRR cuts every time FX reserves fall. Yao explains:
“The PBoC has expanded its domestic assets quickly, but just quickly enough to offset the declines in its foreign assets. At the same time, it is targeting a level of short-term interbank rates and providing liquidity accordingly…
PBoC’s claims on banks have more than doubled since the beginning of the year, but the total size of its balance sheet has barely grown, with official FX reserves falling further, albeit at a slower pace. This process of domestic assets replacing foreign assets has led to a rapidly rising share of domestic assets from less than 20% a year ago to 27%, reversing a decade – long sliding trend.
The expansion of domestic assets was made possible by the whole gamut of standing facilities introduced in the past two years, with duration ranging from a few days (SLOs), one month (SLFs), 3 to 6 months (MLFs) to 1 to 3 years (PSLs).
The outstanding amount of MLFs increased CNY1.3tn between August 2015 and August 2016. PSLs followed with an increase of CNY965bn. SLOs and SLFs have been used to plug temporary liquidity shortages.
The biggest benefit is that China’s central bank can finally target prices, instead of a quantity, of money.”
All in all, it looks as if China’s central bank is handling the country’s stuttering economy effectively… for the time being at least.
By Rupert Hargreaves
