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元 Is the Outflow of China’s Currency Really a Problem?

Originally published Jan. 30, 2017

The great engine of China has performed at an amazing pace since the economic downturn of 2009. Annual GDP growth, despite slowing, has performed at:

  • 2010 ~ +10.6%

  • 2011 ~ +9.5%

  • 2012 ~ +7.9%

  • 2013 ~ +7.8%

  • 2014 ~ +7.3%

  • 2015 ~ +6.9%

  • 2016 ~ +6.7%

Details summarize that China’s economy is expanding at the slowest pace in not only seven years, but in more than a quarter of century. Conversely, there has been significant investment in the economic engines of South Asia and the ASEAN region since 2010. The outcome, although positive for Asia, has increased the competitive landscape significantly and strained China.

Currently, there is enormous overcapacity in China, which has slowed growth and increased financial risks in the market. Despite years of impressive growth led by central leadership, there is pressure on The Ministry of Commerce (MOFCOM) to stop the regression of annual GDP growth. Neither a stimulus package, nor an adjustment in interest rates is going to ease uncertainty about recovery.

There has been a lot written about the outflow of currency from China. Capital has been flowing out of China at a remarkable pace – over $50 billion per month over the last year, according to official bank data. Goldman reported that $1.1 trillion in capital has left China since August 2015 — more than twice what its central bank has reported. There are many potential reasons for this outbound activity.

Why is capital leaving China?

Investors and companies fear a continued decline in the value of the Chinese currency – the Yuan.

  • Jan. 27, 2015 – the Yuan closed at 6.25

  • Jan. 25, 2016 – the Yuan closed at 6.56

  • Jan. 20, 2017 - the Yuan closed at 6.85

  • YoY, the Yuan has depreciated 4.4% with a 9.6% decline in two years.

The country’s central bank is fighting to prop up the value of the currency. In spite of this, the Yuan keeps getting weaker and weaker, while the US economy strengthens and the dollar surges.

Additionally, many companies have been paying off their dollar loans and others are pursuing international acquisitions.

Furthermore, investors are becoming increasingly nervous about the dangerous levels of bad debt circulating through China’s economy, which is the second largest in the world.

But the Outflows Continue

China recently tightened capital controls to prevent individuals and companies from moving more money out of the country. This is an organized attempt to clamp down on outbound Mergers & Acquisitions in a struggle against capital flight.

“This doesn’t mean the Chinese government is cracking down on legitimate M&A activity,” said one Beijing-based investment banker. “They are just exercising more control, which is necessary. The volume of outbound M&A is mind-boggling in terms of how fast it’s growing.”

“This is a big move,” said Wang Jun, an economist at China’s Center for International Economic Exchange. “The government has stepped up capital controls to prevent further depreciation of the renminbi.

Rules to tighten the deal approval process take shape as Yuan and Forex reserves fall. China's foreign-exchange reserves have fallen more than $800 billion in two years.

Officials have implemented numerous capital-control measures in a bid to stem the tide. The State Council is most concerned about outbound mergers and acquisitions worth more than $10bn; and it was stated that Chinese officials would scrutinize purchases of more than $1bn if they were outside the investor’s core business.

News of the stricter measures worried many investors and companies interested in international M&A. However, Chinese regulators often relax and tighten rules informally, allowing companies to respond to changing market conditions.

Is the Outflow of China’s Currency Really a Problem?

No. Despite the economic challenges outlined above, I believe it is both strategic and reasonable for Chinese officials to continue to allow for international investments outside of the country, especially where the impact is positive for their core business and a low risk, calculated way to diversify their portfolio.

I am particularly keen to international investments that provide a sustainable channel of distribution for the investing Chinese company.

This is not capital flight. This is not really a problem.

Jeff Streader

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