Event

Stronger external pressures on the RMB are making life more difficult for the Chinese authorities as capital outflows have accelerated since Mr Trump’s election. The People’s Bank of China is using a larger amount of foreign exchange reserves to slow down the RMB depreciation which reached 7% against the USD in 2016, i.e. the biggest drop since 2005, when the RMB was de-pegged from the USD. In addition, it was decided to tighten some capital controls on overseas transfers, targeting Chinese intercompany’ loan repayments and dividend remittances to foreign shareholders above an amount equivalent to USD 5 m. The State Administration of Foreign Exchange’s approval is now required or conditions have been tightened for those transfers outside China. This might delay them and hinder business for foreign groups active in China. Those measures come a few days after restrictions were imposed on Chinese groups’ ‘irrational’ external acquisitions in non-core business (e.g. real estate, sports,…) seen as disguised ways to take money out of China.

Impact on country risk

China’s capital account is only partially and gradually liberalised as many restrictions exist on capital flows. The latest controls mainly consist in a tightening aimed at intensifying the government’s complex fight against capital flight as more money is being repatriated to the US and investors are expecting a further RMB slide against the USD. Still, it is worth pointing out that the RMB has been appreciating against other hard currencies. Planned higher US interest rates, a strong USD, potential trade tensions with the US, but also possibly recent capital controls, highlighting the deteriorating investment environment, should support the current trend of capital outflows and RMB weakening. Foreign exchange reserves are still ample but have shrunk by about 20% in the past two years (see graph below) and therefore require complementary tools to maintain stability, particularly in a year where half of the country’s leadership will be changed during the National Congress. As a result, in case of persisting strong capital outflows, Beijing might have to tighten further capital controls and soon lift interest rates even though this would harm the extremely indebted corporate sector. In a year of high uncertainty, a gradual depreciation of the RMB is more likely than a (large) devaluation as Beijing wants to avoid fuelling panic and the RMB was recently integrated into the IMF’s SDR currency basket. Looking ahead, the easing of capital outflow pressures will largely depend on the government’s ability and willingness to tackle, in a determined manner, critical economic issues dominated by the heavy corporate debt and banking sector assets deterioration.

Analyst: Raphaël Cecchi, r.cecchi@credendo.com