Are jittery Chinese investors dumping Chinese assets and leaving the country, as China bears like George Soros and Kyle Bass claim? No, says Bank for International Settlements economist Robert Macauley, one of the most respected analysts of Asian capital movements. The real story is much less exciting. Chinese corporations paid down dollar debt and reduced offshore RMB deposits in anticipation of a decline in the RMB against the dollar during the third quarter of 2015, Macauley and BIS colleague Chang Su show. During the long years of RMB appreciation against the dollar, Chinese corporations took out loans in dollars, expecting to pay them back in appreciated RMB. Now they are repaying dollar loans. They are also shrinking their holdings of offshore RMB deposits, which they accumulated in anticipating of a rising RMB.
The BIS analysis suggests that China’s capital outflows did not reflect panic liquidation of Chinese assets. Chinese companies, rather, simply adjusted their balance sheets to a changing exchange rate environment. China had a record drop in official reserves, but Chinese corporations at the same time had a record drop in their dollar debt. The BIS economists report:
We start with a record $175 billion net decline in BIS reporting banks’ cross-border loans to China in Q3 2015 left-hand panel, blue line), almost double the outflow in Q1. It reflected both a sharp decline in loans to China and continued growth in liabilities to China (ie China’s cross-border deposits). The new SDDS data show that $12 billion of this Q3 outflow was due to an increase in Chinese official foreign exchange reserves deposited at banks located outside China (a capital outflow). That leaves $163 billion of non-reserve outflows to be accounted for. National and BIS data suggest that these outflows through BIS reporting banks reflected a reduction of (i) renminbi deposits offshore, (ii) net dollar debt of Chinese firms cross-border and (iii) their net debt within China.
A chart published in the report, which appears in the just-released issue of the BIS Quarterly report, tells the story in three parts.
The left-hand graph shows a sharp drop in Chinese corporations’ external foreign currency claims, as record in the BIS’ comprehensive reporting system. This was the biggest drop on record, and represents a de-leveraging of foreign currency exposure–quite the opposite of a crisis.
The center graph shows that the change in Chinese holdings of RMB offshore followed the depreciation of the RMB agains the US dollar.
The right-hand graph shows that domestic foreign currency loans to Chinese corporations from Chinese banks declined as the CNY/USD exchange rate declined.
A big part of China’s problem is the appreciation of China’s currency in trade-weighted terms. The soaring US dollar during 2014 pushed up the RMB real effective exchange rate by nearly 20%, by the BIS’ reckoning. That hurt China’s exports by raising the cost of its goods offered for sale overseas.
In August 2015, the People’s Bank of China began to take action to reverse the RMB’s appreciation in August 2015–without signaling to the market what it had in mind. A drop in the RMB rate contributed to the mini-panic that gripped world markets during August. China subsequently announced that it would target a basket of currencies rather than the US dollar. Chinese corporations who had geared their balance sheets towards RMB appreciation rushed to pay off dollar liabilities.
The first quarter of 2016 might see more of the same, the BIS economists conclude: “The PBoC’s declared intention to keep the renminbi stable in effective terms would imply a weaker renminbi against the dollar were the dollar to appreciate against major currencies. In this event, offshore depositors might not hold onto maturing renminbi deposits and Chinese firms would still have reason to repay dollar-denominated debt.”