Why US$3 trillion is the most watched number in China

The expected release this Saturday, January 7, of China’s foreign exchange reserves data for the month of December 2016, will be an indicator of how the regulators will respond to the capital outflow in the short-term. A figure that breaches the psychological US$3 trillion mark is likely to spur further tightening measures.

The clampdown of capital outflow in 2016 has clashed with the efforts in recent years by China to push for the internationalization of the renminbi. It followed a robust effort by companies to set up renminbi cross-border cash pools, and integrating the currency to become part of global treasury management structures.

An indicator that the central bank, the People’s Bank of China (PBoC), is likely to remain vigilant in monitoring capital outflow, was the release at the start of the year of new regulations on foreign exchange for Chinese citizens. The measures come on the back of accelerated overseas investment by Chinese nationals in 2016. Since the foreign exchange reform in August 2015, the yuan has depreciated from 6.2 yuan to over 6.8 yuan against US dollar.

The new guidelines bar Chinese citizens to use exchanged foreign currencies to invest in real property, securities and investment-linked insurance products. In addition, those who wish to buy foreign currencies for justifiable purposes, such as overseas education and travelling, should now have to fill in an application form when applying for foreign exchange. Aside from those prohibited activities, they can still purchase as much as US$50,000 per year.

Violators face draconian sanctions from the PBoC. Those who move capital out of China from different accounts could face a 30% penalty on the amount they transfer out. Furthermore, those who violate the rules will be blacklisted by SAFE (State Administration of Foreign Exchange) and will not be able to enjoy a US$50,000 exchange quota for two years. In addition, violators may even face an AML (anti-money laundering) investigation from the government.

According to a report from Natixis at the end of 2016, capital outflows from China remain significant, fuelled by acquisitions by companies abroad and also by speculative capital outflows linked to the weakening of the yuan against the US dollar. Currently, the Chinese foreign exchange reserves are at a little over US$3 trillion, which is regarded as the alert line by Chinese analysts.

The recent restrictions by the PBoC translate to a limited number of available legal investment approaches for Chinese investors wishing to gain overseas exposure. Those include the QDII (qualified domestic institutional investors) scheme, Shenzhen/Hong Kong Stock Connect and Shanghai/Hong Kong Stock Connect. For those who own foreign currencies in China, they can only invest in foreign currency deposits or a few wealth management products.

Meanwhile corporates face more complex approval processes in the operation of cash pools and global netting centres. Although these activities remain permissible, the regulation has dampened interest. Banks have to work with their clients to formulate customized netting solutions in the meantime.

Netting has attracted particular interest from large corporates with a multitude of subsidiaries that trade with each other. According to a study conducted by Asset Benchmark Research, the return on investments can be significant for groups that fit into this category. “It enables corporates to leverage the concept of centralized payments and collections to better manage their working capital,” the report points out.