Are Chinese people finding ways to circumvent rules and regulations in order to get their money out of the country? Yes, without doubt. Are China’s authorities currently bent on stopping them? Again, yes. To have said that, though, is to also to say ‘situation normal’. What matters is whether this capital outflow is sabotaging all other economic activity; and whether the government’s attempt to stop it has leapfrogged all other economic and policy goals. And the answer to both those is ‘not yet’.
The most important truth about China is trivial to state but very hard to comprehend: China contains multitudes. Within those multitudes it is always possible to produce stories and data proving one thing, and also stories and data disproving the same thing. When the news from China is contradictory, that’s not inaccurate reporting so much as the only possible result of fair representation.
And so to the arguments about capital flight. The important question is not ‘can we identify avenues of capital outflow?’ but ‘Is capital flight accelerating in a way which undermines China’s financial system and economy’. True ‘capital flight’ is tremendously damaging, as it represents an determination to avoid a certain penalty (major inflation, major devaluation) which overrides all the normal prompts which usually keep economic and financial activity ticking over.
Now, no doubt households and companies would like to spirit away some Rmb offshore, or convert it into dollars, and some are certainly doing so. The scheme by which Hong Kong’s insurers sold HK$21.1bn worth of products to mainland UnionPay holders during Jan-Sept 2015 attests to that. But this is obviously not the only agenda motivating households, corporates, and the financial system. For there is another conflicting agenda corporates have to address: banks are fretting about their loans, suppliers are increasingly demanding cash, and there’s only so much inventory to be turned into cash. In these circumstances, it is only the free cash at the margin that has the luxury of getting on the plane to Hong Kong. And for now, the bulk of the evidence suggests that on balance, the desire to survive the squeeze is trumping the desire to send capital abroad.
Similarly, dealing with ‘capital flight’ is only one of a number of goals upon which China’s policymakers are bent, and it’s not yet clear it has become prioritized over the strategic economic and financial goals China’s policymakers have spent years war-gaming.
In my time there have been two episodes of capital flight from China, both of which posed fundamental challenge to the financial, and later the political, system. The first was in the late 1980s, and the second was in the early 1990s. In its aftermath, Zhu Rongji was given the mandate to push through the fundamental reforms to the financial system and central planning which laid the foundations for the prosperity China has won during the last 20 years.
Although different in details, both episodes had similar primary characteristics:
i) inflationary pressures had mounted without an effective policy response, resulting in surging inflationary expectations;
ii) reserve money ballooned in response to depositors taking their money from the banking system (which in turn intensified i); and
iii) the trade balance deteriorated suddenly and sharply.
None of that is happening currently. In fact, the reverse is happening.
i) By December Inflation was running at 1.7% yoy only, and although this is likely to rise slightly during 2016, more economists are worried about deflation than inflation;
ii) Reserve money is actually falling, down 6% yoy in December. Despite that, Rmb bank deposits rate are growing at 19.2% yoy (whilst bank lending is growing at 15%) and during 2015 banks enjoyed a net inflow deposits (less loans) of Rmb1.256tr. In the last three months of the year, that net inflow was Rmb150bn, better than the Rmb237bn net outflow experienced, on average, during the previous three years.
iii) The trade surplus continues to grow: December’s US$60.09bn surplus was up 21% yoy, and during 4Q the surplus of US$175.8bn was up 17.3% yoy.
This configuration of data suggests that although at the margin people and companies are seeking ways to shelter from possible devaluation, the core aim of most economic actors is to survive the liquidity squeeze.
This also shows up, perversely, in some data which is claimed as evidence for capital flight: viz, the discrepancy in China’s account of its exports to Hong Kong and Hong Kong’s account of its imports from China. The underlying problem of the trade data is this: during December China said it exported US$45.93bn to Hong Kong, but Hong Kong reported it had imported only US$23.7bn from China - a discrepancy of US$22.2bn.
It is strange to view this as an expression of capital flight. Chinese traders have forever used trade with Hong Kong to circumvent China’s capital restrictions, under-or-over invoicing as necessary. But if you want to smuggle capital out of China, you don’t exaggerate your exports to China. Quite the reverse: if anything, you would exaggerate your import bill, since that would provide you with a ‘legitimate’ way to send money abroad.
There is an altogether more obvious reason why Chinese companies might over-invoice their exports to friends in Hong Kong. To be polite, it is a way of maximising the tax rebates paid by the government to companies on their export earnings. At the end of a tough financial year, a quick boost to these rebates will be particularly attractive. One also cannot discount the possibility that exporters might be able to win more favourable financing terms from their banks if able to show a healthy growth on their export earnings ‘outstanding’.
None of this is to say that capital flight isn’t happening, or that the government isn’t concerned by it. It clearly is happening, and clearly the government would like to stop it if possible. But that doesn’t mean it has forced its way to the top of the government’s policy agenda - rather, it has become a slightly more important member of the competing claims on government attention and time.
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