China’s Struggle with Capital Flows

- Opening up capital accounts in China may exaggerate excess liquidity near term — "Recent measures by China to encourage outbound investment likely aims to alleviate excess domestic liquidity and to help diversify excess FX reserves. But as policy continues to support exports, the reserves would only become more excessive in coming years."
- USD assets have already been reduced sharply, further cuts difficult — "We update a study by Brad Setser on China’s reserves and US asset holdings. We found that USD’s share of China’s total FX reserve assets had fallen from 73% in end of 2008 to 58% in June 2010. USD’s share of new FX purchases has been cut to about 30%. Given that the US accounts for a majority of China’s trade surplus, it would be difficult to further reduce purchases of USD assets."
- China’s total FX assets already exceed $3 trillion — "After folding in FX assets on the books of the central bank and the rest of the banking system, we found an extra $566bn on top of the $2.454tn published by SAFE."
- FX reserves may continue accumulating at $250-300bn in the next few years — "The trade surplus is likely close to $200bn this year, at par with $197bn in 2009. We see the surplus staying at $150-200bn over the next couple of years. Moreover, net FDI and portfolio inflows could each contribute $50bn a year."
- Offshore RMB settlement may actually boost FX reserve accumulation — "When appreciation expectations are alive, businesses would pay for imports with RMB rather than use FX revenues from exports, which would be used to buy more CNY. The result is more CNY abroad and more FX in China’s reserves."
- Market implications — "China would likely still invest one third of new reserves in USD assets ($80-100bn a year), possibly favoring agency and corporate securities, as long as the recovery doesn’t falter. USD’s share of the total portfolio should still fall. Euro, EM and commodity currencies would likely pick up the bulk of the remaining new reserve accumulation. Investments in Japan could be risky with already expensive yen."
- Investing excess reserves would have international repercussions — "Exporting the massive amounts of liquidity could be destabilizing for smaller economies, potential for political friction. This issue would only grow as China reduces the weight of USD in its expanding portfolio."
- Overseas direct investment (ODI) and portfolio outflows face hurdles — "We do not doubt the potential for China to export capital, but ODI must overcome the state owned stigma to be more accepted abroad. QDII must overcome the poor performance stigma from the first batch of funds. Further privatization and financial market liberalization could help improve these conditions."


No comments:

Post a Comment