China capital outflow accelerates

Cross-posted from Investing in Chinese Stocks.

The money outflow intensifies, China Sees Biggest Outflow of Capital Since at Least 1998:

China’s capital account posted the widest deficit since at least 1998 in the fourth quarter as companies in the world’s second-largest economy increased overseas investment.

The capital account shortfall was $91.2 billion in the three months ended December, the Beijing-based State Administration of Foreign Exchange said on its website Tuesday. The current account surplus shrank to $61.1 billion, it said.

“This signals a shift in China’s economic structure,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. “The expectation of yuan depreciation has appeared and that helped the capital outflow.”

What’s driving outflows? Arbitrage, as the offshore yuan is pulling the onshore yuan lower:

A Hong Kong bank foreign exchange trader admitted that the driving force behind it, it intensified the arbitrage the difference between the onshore and offshore renminbi.

Chinese businesses are exchanging RMB for USD in Mainland China and immediately shipping it to Hong Kong in order to buy RMB at the more favorable rate. According to one HK broker interviewed:

“The basic difference between the proceeds will sink more than 80 basis points of the day.” He said. This means that if a company invested $ 100 million fund to participate in arbitrage operations, every day at least be able to create about $ 800,000 profit.

This profit opportunity has created a wave of arbitrage trading, leading to the RMB hitting its lower limit over and over again.

This same arbitrage wave happened in 2011/2012. This is also not dissimilar from the interest rate arbitrage wave in spring 2013. Then, fake exports drove a yuan rally as dollar flows moved the other way in order to cash in on interest rate differences. Businesses have seen their margins collapse and instead of conducting normal operations, firms have turned to these type of arbitrage trades. And like the interest rate arbitrage of 2013, these currency trades are evading China’s capital controls:

However, due to capital control measures taken within the enterprise to complete these arbitrage operations, no easy task. For example, the large number of dollars to purchase foreign exchange income of how quickly the territory of Hong Kong to sell foreign exchange market is a difficult problem.

Some firms are using Hong Kong subsidiaries to conduct arbitrage and evading taxes in the process. Instead of bringing U.S. dollars onshore, they exchange dollars for RMB in HK, and exchange RMB for dollars in the Mainland:

A trade business executives said, in fact it is not difficult for some domestic enterprises. Their usual practice is to first set up a “window” in Hong Kong, by the company with domestic companies signed a series of trade contracts, will be able to trade under the rapid dollar sinks to achieve arbitrage window company accounts. Even some companies in order to accelerate the speed of the carry trade, let outside window of dollars in the hands of the company will sell the settlement, and then make up the territory of dollars to purchase foreign exchange income gap.

He admits, the benefits of this approach, not only to help companies a lot of “stranded” in the window outside the company’s profits tax avoidance, but also taking the appropriate exchange differences gains.

As long as the offshore yuan continues to decline and the PBOC fights the market’s pull, there is an unending opportunity for arbitrage. The dollar outflow switch is jammed in the on position.

Some traders wonder if the PBOC will make these trades illegal:

Many banks forex traders not without worry that if the spot exchange rate of RMB and then continued pressing in the limit, do not rule out the central bank may take the exchange rate interventions to curb the behavior of this type of arbitrage.

They aren’t worried though, because they believe they are assisting the PBOC in fighting yuan devaluation. If the PBOC needed to defend the yuan in HK, it would have to spend the dollars itself.

Traders believe the onshore RMB reflects the PBOC’s desires, while the offshore yuan represents the market and foreign institutions’ expectations.

Some degree of refraction of the former Bank of the RMB exchange rate fluctuation range of management’s intentions, the latter on behalf of foreign institutions to predict the future direction of the RMB exchange rate movements.

Another good time to review The Informational Power of the Offshore Yuan Exchange Rate.

Unlike in the past, today traders believe yuan depreciation is a possibility thanks to the strong U.S. dollar rally:

In the case of the previous few years, unilateral RMB appreciation, even if the exchange differences exist between more than 100 basis points, and rarely trigger poor domestic foreign exchange arbitrage. The reason is that most organizations are more willing to wait for the appreciation of the renminbi to hold gains.

However, with the recent strength of the dollar appreciation and China’s economic slowdown, this situation is being reversed rapidly.

He recalled that before the January 26 approaching the lower limit of RMB spot exchange rate for the first time, the Hong Kong dollar against the RMB NDF market than the domestic market offer low 247 basis points, triggering early that day, many enterprises to purchase foreign exchange in the domestic market, then those dollars all transferred to the Hong Kong foreign exchange, cash in exchange differences 247 basis points.

Because of this arbitrage Gouhui disk tide caused the domestic market, the spot exchange rate of the renminbi will soon trigger limit was approaching.

“Since last week, a similar phenomenon has occurred many times.” He said that many companies are based on the US dollar overnight index rose to predict the yuan decline in the morning before the day down against the dollar NDF market quotes, widen the yuan domestic foreign exchange difference, then the massive purchase of foreign exchange in the territory, take the dollars and exchange for NDF to lock in exchange rate differences.

As Chinese forex reserves fall, the pressure for yuan devaluation increases. As those expectations are expressed in a lower offshore yuan, this creates arbitrage opportunities. Arbitrage trades drain U.S. dollars from the Mainland, pulling China’s forex reserves lower, putting greater devaluation pressure on the yuan. This trend was short circuited in the past because investors expected the yuan to appreciate versus the U.S. dollar. Those expectations have changed.

The PBOC cannot jawbone the yuan higher or pull the market higher by refusing to depreciate the onshore yuan. All that will accomplish is a steady outflow of U.S. dollars that increases the expectations of yuan devaluation.

The market is playing a larger role in the yuan’s value thanks to the internationalization of the yuan, but also because the market is relying on the informational power of the offshore yuan, the market priced yuan. Investors are trusting the market more than the central banks all over the globe, and China is no exception. 21CBH: 外汇交易员详解人民币五跌停境内外资本汇差套利魅影寻踪

Meanwhile, the outflow tightens credit. Last year land finance hit a new high of nearly ￥5 trillion. (去年“土地财政”创新高：地方卖地收入超四万亿) but land financing revenue growth collapsed and local government finances face an unresolved predicament (土地收入增速骤减地方融资困局待解):

“Daily Economic News” reporter’s inquiries learned that the budget report for the local governments forecast land revenue of 4.31 trillion yuan, down 10.1%. Among them, the state-owned land use right transfer income of 3.63 trillion yuan, down 11.8%.

Instead of falling, state-owned land transfer revenue climbed 17%. However, this growth was still a shadow of the 44.6% growth in 2013.

The spike in land sale revenue was the result of the government’s crackdown on borrowing by local governments. Even though prices were down, governments were able to raise revenue by increasing land supply. Regular revenue channels brought in only ￥2.6 trillion in revenue. At nearly ￥5 trillion, the land finance reliance ratio was 192% (as the Chinese report it) or a still incredible 66% of total revenues. It gets worse because a big chunk of that ￥2.6 trillion was the result of real estate taxes:

Treasury data show that the local general public revenue (this level) 7.59 trillion yuan. That is, the local land revenue has more than half of the local public revenue.

In addition, land and real estate taxes also include small local taxes. Ministry of Finance data showed: deed 398.6 billion yuan, an increase of 3.7%; land tax 391.4 billion yuan, an increase of 18.8%; farmland occupation tax 205.9 billion yuan, an increase of 13.8%; urban land use tax 199.3 billion yuan, an increase of 15.9 %. Several data add up to 1.2 trillion yuan.

In addition, the real estate business tax 562.7 billion yuan, 296.1 billion yuan real estate business income tax, partly returned to local governments.

The slowdown in land finance comes as local governments face ￥650 billion in maturing debt this year. Cities aren’t going to default, but if they don’t have excess cash to finance infrastructure and development projects, growth will slow.

Here’s some background: May Land Sales Plummet; 300 Cities Down Nearly 40%; Some Cities Have No Sales

f land sales continued at the rate seen in May, the annualized sales would be down 60% from the ￥4.1 trillion sold in 2013. First quarter land sales of ￥1 trillion were on pace to match 2013, but those numbers look good due to sales in January and February. A significant portion of many city budgets is funded by land sales and land sale revenue is also used to back some debt. Even if sales bottom out or rebound slightly, the decline is already large enough to constrain budgets in cities that overly rely on land sales.

June Land Sales Plunge

Even first tier cities are seeing land sales collapse. According to Centaline, through June 16, the four first-tier cities had sold only 8 parcels of land for ￥1.8 billion. The firm forecasts land sales will be below ￥20 billion for the month, the lowest figure in the past several years. Last year, the four cities sold ￥35.7 billion worth of land.

Land sales picked up in the second half of 2014, but they were heavily split. Top-tier cities saw land sales rebound strongly, while bottom-tier cities saw sales drop to zero. The lack of finance will be an issue for cities in the first half of 2015.

Finally, China’s subprime borrowers, the developers, are also unable to get finance S&P cuts China developer Glorious’s credit rating on refinancing worries:

China’s Glorious Property had its credit rating cut by Standard & Poor’s on Tuesday, the latest red flag to be raised about Chinese developers’ ability to service their debt.

S&P cut the rating by a notch to CCC, saying it was concerned about the company’s ability to refinance $300 million of bonds that are due to mature in October. The agency warned there could be a further downgrade for the troubled borrower closer to the bond’s redemption date.

The company’s plans to deal with the debt tells the story of the real estate market as a whole: accelerate projects to recoup capital. The result is faster inventory growth and falling prices. Xinhua: 恒盛地产身陷债务违约遭标普下调评级 (Glorious Property in Default Trap)

“If these companies do not have any positive development, it will face some liquidity difficulties or need to deal with some cheap deal to repay debt.”

Ye Ao bank also introduced, “CCC +” mainly for no short-term difficulties, but the long-term sustainability of the company is questioned; “CCC-” means the company may default within six months.

In fact, over the past few years, the “debt” has been accompanied by Glorious Property vocabulary, and appear to be more serious this year. Because, on the Glorious ended the first half of 2014 data, the losses of 221.3 million yuan, and may not be a small number. Meanwhile, in addition to first-tier cities in the sales Nanjing, Changchun and other second and third tier cities, the Glorious repeated negative news now.

As of press time, the reporter has been unable to contact the Glorious estate executives. But there is news that President Glorious Ding Xiangyang said in an interview that the company will increase the next two years, the layout of Shanghai, Nanjing, Beijing, Tianjin, Hefei and other second-tier cities, and gradually reduced until you exit the other three in the Northeast four-city project layout. At the same time, 2015 will accelerate the construction of the projects, increase sales, improve cash flow rate and reduce the debt ratio.

In the survey, some industry analysts, told reporters that the biggest risk is still the Glorious “political risk”, not only is the debt risk, “another listed company in Hong Kong is probably a lesson. But fortunately, the announcement to Look, they sacked the company and some politicians does not matter. “

You can tell the state of affairs when the lack of political risk is taken as a good sign.

The punchline: by one report, 90% of developers (mainly small and medium firms) are already insolvent, but the since the big firms are “too big to fail,” the government will bail them out and the sector will avoid an economic chain reaction.

China Financial Intelligence chief financial experts Hao Wang findings for 2014 was more than 100 cities, said, “90 percent of the Chinese real estate developers have already insolvent, bank loans, trust, SME debt, private equity, private lending, high interest and other financing instruments together and 90% of all real estate firms’ debt ratio above 150% -200%. ”

“Perhaps, not so exaggerated. Some SMEs may face some difficulties, but overall, the market is still healthy, still belongs to a small part of the problem.” Xue Jianxiong insists.

The four-city developers also believe that some real estate companies are now part of the “too big to fail” mean, because, once after another fall, involves more than just a company problem, there are other aspects of the problem. So, overall, fallen or breach, may still in the minority.

Tenured professor of Economics, Texas A & M University, USA, Dean of Economics and Management Institute of Southwest University of Finance and sweet plow had, “International Finance” reporter suggested that in order just in case, “relevant or should the real estate industry as soon as possible stress test, try to avoid systemic risk. ”

“In fact, at this stage, the real impact of the largest, than the original sacked politicians and too close to the real estate business. For example, another listed company in Hong Kong.” Xue Jianxiong think, “Perhaps, this is their The biggest risk. “correspondent Huang Ye

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About the author

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.