From the FT:
Chinese companies and residents sent more than $110bn out of the country in January alone, according to new estimates, as they continued to evade tightening capital controls amid another round of market turmoil.
Surging capital outflows from China have become a source of growing concern around the world and left Beijing scrambling to support its currency. Recently-released data showed the country’s foreign exchange reserves falling to their lowest level in almost four years in January.
In the first significant attempt to digest the capital flight amid January’s market turmoil in China, the Institute for International Finance estimated that $113bn had been sent out of the country in the month.
So, China is tightening these channels wherever it can and with increasing ferocity as well as defending the yuan by selling its US dollar reserves. But, it can’t do that forever, indeed another few months of it and falling reserve will spook markets and accelerate the outflow. So what are its options? Barry Eichengreen lists them at Project Syndicate:
What, then, is China’s least bad option? The authorities could continue with their current strategy of pegging the renminbi to a basket of foreign currencies, and push ahead with their agenda of restructuring and rebalancing the economy. But convincing skeptical observers that they are committed to this strategy will take time, given recent missteps. Meanwhile, investors will bet against them.
…Alternatively, the renminbi could be allowed to fluctuate more freely. The People’s Bank of China can permit it to depreciate against the reference basket by, say, 1% a month, in order to enhance the competitiveness of Chinese exports and address concerns that the currency is overvalued.
But, given weak global demand, this kind of modest depreciation won’t do much to boost exports and support economic growth. Moreover, with the renminbi losing 1% of its value each month, capital flight would accelerate further.
A third option is a one-time devaluation of, say, 25%. This would enhance export competitiveness at a stroke. Depreciate the currency to the point where it is significantly undervalued, the argument goes, and investors will expect it to recover. Capital will then flow in, not out.
This assumes, of course, that everyone buys into the idea that one devaluation doesn’t augur another. It assumes that investors would be unperturbed by the authorities’ abandonment of their prior vow to shun a mega-devaluation. It ignores the fact that Chinese enterprises, already in dire straits, have as much as $1 trillion of foreign-currency debt that would become significantly more difficult to service. And it minimizes the devastating economic impact of a mega-devaluation on countries with which China competes.
By process of elimination, the only option that remains is tightening capital controls. Strict controls can prevent residents and foreigners from selling renminbi for foreign currency on onshore markets and transferring the proceeds abroad.
Protected by this financial Great Wall, the authorities could let the exchange rate fluctuate more freely and allow it to depreciate gradually without provoking capital flight. They would gain the time needed to implement confidence-building reforms. They could curtail the provision of liquidity to loss-making enterprises, forcing firms to eliminate excess capacity. They could restructure problematic debts. They could recapitalize banks that suffered inadvertent balance-sheets damage as a result of these reforms. They could repair their damaged credibility.
We’re already on this path and it is its logical conclusion. It is what I would do were I China and continue reforms once the exchange rate issue was neutralised. The other options would not work anyway in the broader political economy. They cannot let the reserves bleed away for much longer. That is inviting a banking crisis. They cannot unilaterally devalue without blowing markets sky high as deflation fears rock the world. That is inviting global crisis. Capital controls is the least worst option.
However, it is not an outcome that would work well for Australia as the flow of funds into commercial and residential real estate would come to a rather sudden stop.
