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China pulls out all the stops to halt capital outflows


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Opinion: China pulls out all the stops to halt capital outflows

By Craig Stephen
Published: Apr 12, 2016 10:02 a.m. ET

The country has won, for now, but the long-term trend says otherwise

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The first increase in foreign reserves in five months suggests China has won the battle with speculators who are shorting the yuan. Yet, winning the war and ending fears that a currency devaluation is inevitable will remain without signs the economy is on a sustainable path.

There are a number of reasons to believe the reprieve is only temporary. For one, there appears to be an element of good fortune, or the stars being aligned, to deliver the $10.3 billion boost to reserves to $3.21 trillion in March.

Healthier reserves are partly due to currency revaluation. Société Générale estimates some $40 billion is due to the weakening of the U.S. dollar after the Federal Reserve’s recent more dovish tone. This would have also been even more unlikely had attempts by the ECB and the Bank of Japan to weaken their respective currencies in recent months with negative interest rates not backfired.

As it turned out after falling 1.3 % in January, the yuan stabilized in February and then appreciated 1.6 % against the U.S. dollar last month.

But if this currency trend reverses with any resumption in U.S. dollar strength, capital outflows could again pick up.

The other reason it’s premature to declare victory is this improvement is not due to the market finding balance but rather the heavy hand of state intervention. Beijing has compelled various financial institutions to deal in forward currency markets, while capital controls have been tightened on areas of leakage such as gaming in Macau or offshore purchases of foreign insurance policies.

This crackdown appears to be continuing. New measures by authorities to restrict capital outflows by targeting its citizens shopping abroad suggests Beijing remains on a war footing.

This past weekend, a range of tax hikes on goods sent into China by mail came into effect, removing lower taxes on various personal postal items. Together with tighter restrictions on the quantity of goods purchased abroad that can be brought back tax-free in personal luggage, the new policy targets so called “diagou,” or professional-shopping, business. This has been a huge business, worth up to 75 billion yuan a year for luxury goods by some estimates.

According to Fitch, these curbs will benefit domestic Chinese retailers as it narrows the differential between luxury goods bought abroad and in China.

The scale of spending abroad by Chinese tourists was always likely to have come under the scrutiny of authorities as capital outflows intensified in recent months. Chinese tourists do as much as 80% of their luxury-goods spending overseas, which has led to an annual spending deficit, estimated at some $100 billion.

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The hope is these measures will promote more shopping at home. Fitch notes the boom in overseas spending has come at the direct expense of domestic department stores and luxury-goods retailers.

Another interpretation is they just highlight another pain point from Beijing persevering with an overvalued currency following devaluations by so many other countries.

Most often, currency wars — or competitive devaluations — are viewed in terms of one country trying to steal another’s share of trade. China is certainly hurting here with February’s 25% year-on-year drop in exports, marking its eighth straight monthly loss.

But we can also add lost or displaced consumption by shoppers to the negative side effects of the current policy of supporting the yuan.

How effective these new administrative measures will be remains to be seen, although Fitch reports suggest authorities are being more strict in enforcing new restrictions.

The bigger picture is the attraction of purchases overseas by Chinese is not just about taxes but how far the yuan goes.

This is the case, be it holidays in Thailand, real estate in Australia, or luxury goods in Japan or Europe. This is also the same for China’s corporates, which have been engaged in an unprecedented buying spree this year, with outbound mergers and acquisitions already surpassing the whole of last year at over $100 billion, according to Dealogic.

These trends will be hard to change by tinkering with tax rates alone and not the underlying driver: the currency.

Ultimately, these new measures targeting overseas shopping should be viewed as just the latest salvo in the ongoing battle against money outflows.

The reason concern over China’s currency is not going away comes down to the belief that the current policy path is simply unsustainable. Intervention to support the currency contracts the money supply at a time when credit is already growing at twice the pace of GDP and prices at the factory gate have been falling for 48 months.

It might then come as little surprise that the two biggest risks identified by visiting money managers at Credit Suisse’s Asian Investment Conference last week in Hong Kong were China growth and currency risks.