China Suffers Largest Capital Outflow On Record In 2016 (And It's About To Get Worse)

With the Yuan suffering its largest annual decline ever and avenues for capital flight surging in value (Vancouver homes and virtual currencies), it is perhaps not entirely shocking that, according to the Institute of International Finance, capital outflows from China surged last year to a record $725 billion. Furthermore, IIF warns, outflows could accelerate further if U.S. firms face political pressure to repatriate profits.

As Reuters reports, the Washington DC-based group, one of the most authoritative trackers of capital movements in and out of the developing world, estimates net Chinese outflows last year were $50 billion higher than in 2015, dwarfing the inflows other emerging economies received.

Net outflows in 2014 had been just $160 billion from China, which has seen capital flight pick up in the past couple of years from local businesses and households, partly on expectations that the yuan would weaken against the dollar.

The outflows, which caused a $320 billion decline last year in Chinese foreign exchange reserves, have prompted authorities to strengthen capital curbs.

The yuan fell 6.5 percent against the dollar last year, the biggest ever yearly fall, and with capital controls (or suggestions of them) being implemented almost weekly (here, here, and here most recently), it is perhaps no surprise than Bitcoin (one escape valve) has been resurgent in the last few days (amid Golden Week holiday celebrations).

As Reuters continues, The IIF estimated China outflows at a heavy $95 billion in December and noted that a rise in protectionism, especially in the United States after the election of President Donald Trump, could exacerbate the situation.

Trump and his top trade adviser this week criticised Germany, Japan and China, saying the three key U.S. trading partners were devaluing their currencies to the detriment of U.S. companies and consumers.

"If U.S.-based multinational corporates start to repatriate their profits from China, outflows could worsen further in 2017," the IIF said, referring to pledges of tax breaks to U.S. firms that bring overseas profits back to the country.

But excluding China, the picture for emerging markets appeared brighter, the IIF said, noting net capital inflows last year had amounted to $192 billion, versus $123 billion in 2015.

In January, inflows into the stocks and bonds of a group of big emerging economies stood at a five-month high of $12.3 billion, the group added.

"January was a much better month for emerging markets but it is too early to tell if this reflects hope for a better outlook – or this is just the eye of the storm," the IIF note added.

The capital exodus from China, however, dominates the picture - the IIF last November forecast the developing world would suffer net capital outflows of $206 billion in 2017, with the vast majority accounted for by China.

Chinese Capital Controls Threaten Property Bubbles All Over The Globe As Buyers Lose Access To Cash

For months/years we"ve covered the many real estate bubbles that have been inflating all over the world courtesy of Chinese billionaires looking to launder money offshore (here are just a couple of examples:  Vancouver, Sydney and New York).  But a new set of capital controls enacted in China on January 1st, and aimed specifically at curbing foreign real estate investments, may just be the needle that finally pops all those bubbles.

As Bloomberg pointed out earlier this month, the following new restrictions on foreign currency transaction were implemented earlier this year.

• Customers must pledge money won’t be used for overseas purchases of property, securities, life insurance or investment-type insurance. While such rules aren’t new, citizens previously didn’t have to sign such a pledge


• Customers must give a more detailed account of the planned use of funds, such as business travel, overseas study, family visits, medical treatment, merchandise trade or purchases of non-investment insurance policies, including the timing, by year and month


• Violators of foreign-exchange rules will be be added to the currency regulator’s watch list, denied foreign-exchange quota for three years and subjected to anti-money-laundering investigations


• Customers must confirm compliance with restrictions on money laundering, tax evasion and underground bank dealings


• Customers must now confirm they aren’t lending or borrowing quotas to or from other citizens

And while some of the new capital controls above may not seem that onerous, they"re already threatening real estate deals from London to Melbourne as Chinese buyers are finding it increasingly difficult to fund down payments.

In London, Chinese citizens who clamored to purchase flats at the city’s tallest apartment tower three months ago are now struggling to transfer their down payments. In Silicon Valley, Keller Williams Realty says inquiries from China have slumped since the start of the year. And in Sydney, developers are facing “big problems” as Chinese buyers pull back, according to consultancy firm Basis Point.

“Everything changed’’ as it became more difficult to send money offshore, said Coco Tan, a broker at Keller Williams in Cupertino, California.

Less than a month after China announced fresh curbs on overseas payments, anecdotal reports from realtors, homeowners and developers suggest the restrictions are already weighing on the world’s biggest real estate buying spree. While no one expects Chinese demand to disappear anytime soon, the clampdown is deterring first-time buyers who lack offshore assets and the expertise to skirt tighter capital controls.

“If it’s too difficult, I’m out,’’ said Mr. Zheng, 66, a retired civil servant in Shanghai who declined to give his first name to avoid attracting regulatory scrutiny. He may abandon a 2.4 million yuan ($348,903) home purchase in western Melbourne, even after shelling out a 300,000 yuan deposit last August. He’s due to make another big payment next month.

As further evidence that the tighter controls are working, Chinese banks last month registered net inflows under the capital account for the first time since the yuan’s devaluation in August 2015.

Moreover, as Bloomberg points out, several new construction luxury buildings are now at risk of losing contracted sales as Chinese buyers, once flush with cash, are finding it very difficult to make progress payments.

At The Spire in London, a 67-story tower with sweeping views of the River Thames and flats starting at 595,000 pounds ($751,901), prospective buyers were caught off guard by the new rules. Less than 70 percent of clients who signed purchase contracts last year have made their initial payments, with the rest now facing “problems,’’ a press official at Greenland Holdings Corp., the project’s Shanghai-based developer, said on Jan. 12. The official asked not to be named, citing company policy.

While Beijing’s policy tweak may appear symbolic on the surface, it’s likely to cause a “notable reduction” in Chinese purchases of Australian property, according to Christopher Todd ‘CT’ Johnson at Basis Point, a consulting firm that specializes in business relations between the two nations. Australia approved A$24 billion ($18.1 billion) of real estate investments from China in the fiscal year ended June 2015, the most recent figures available, making the country by far the biggest source of foreign buyers.

And with one bubble on the verge of popping, the only question to answer now is which asset class speculative Chinese billionaires will cause to bubble over next?

To "Prevent Public Panic", Beijing Orders Banks To Keep Capital Controls Secret

China is so concerned about the ongoing surge in capital outflows that its forex regulator, SAFE, has taken the unprecedented step of ordering banks to keep its instructions about curbing capital outflows secret and also to ensure that research analysts do not publish any negative views about the yuan according to Reuters.  According to bankers from local and foreign banks, both demands are seen as an attempt by the authorities to prevent alarm that could trigger further declines in the yuan. 

With the yuan losing 6% of its value against the dollar last year as a result of hundreds of billions in official outflows (and as much as $1.1 trillion in unofficial since August 2015 according to Goldman calculations), Beijing has unleashed a flurry of restrictive measures on capital outflows from the State Administration of Foreign Exchange (SAFE), including setting limits on banks" currency volumes in some cities or provinces and requiring approval for ever smaller transactions. Overnight, the PBOC even unveiled probed into bitcoin exchanges, sending the digital currency plunging over 20%.

Reuters reports that SAFE, which is part of the People"s Bank of China, is insisting, orally, that dozens of bank don"t reveal its role in such restrictions, which was damaging their relationships with clients since they were unable to explain why they were turning away business. SAFE"s reticence began at least as far back as August, when its Shanghai branch called at least 20 of the major foreign and domestic banks operating in the city to a meeting with the regional heads of several SAFE departments.

A representative from an international bank attending the meeting said there were no written instructions, but a high-ranking SAFE official told them explicitly what was expected of them.

"You must control your forex deficit, but you can"t say that SAFE is controlling capital outflows," the official told the bankers. The banks were told to "manage sentiment" to prevent public panic, the banker said, and the banks" research analysts should not broadcast any negative views on the yuan.

As a reminder, while in the US, the real  Fake News is anything having to do with relations between Trump and Russia; in China fake news mostly focus on the economy and the currency (as well as virtually everything else).

"They told us not to publish bad house views - analyst house views - on the yuan", the person said. A second banker on the forex team of an international bank said his bank had received the same instructions. 

Where a bank has exceeded the SAFE-set limits for forex transactions in a month, they have to turn business away, but are unable to explain the real reason why, several bankers complained. "We"re not going to tell our customers that (our forex business) has stopped; we just have to find ways to turn down the business we"re not allowed to do," said a banker at Chinese Commercial Bank Ping An who had received SAFE instructions from seniors.

"It"s not good for client relationships," he added, explaining that he had told his clients to go to other banks.

Additionally, SAFE had told banks to interview clients to make sure the forex deals were not for fake transactions, or else face punishment, according to two bankers at separate listed banks. In response to those orders, one of the banks sent an internal notice to employees, seen by Reuters, to alert them to SAFE"s requirements, explaining that the regulator"s penalties could include "cancelling business qualifications" needed for the lender to conduct forex business.

The notice passed on SAFE"s instructions that staff should not mention the regulator, i.e., it was to be kept secret. 

"Please do not reply to clients using wording such as SAFE controls, or SAFE doesn’t allow or strictly controls FX purchases," it read. Instead, they should adhere to the line provided by SAFE, that the purpose of the changes was to "promote healthy development of outbound direct investment" and "crack down on fake deals", the notice added.

* * *

While China"s foreign exchange reserves fell to $3.05 trillion in November from $3.3 trillion in the first 11 months of 2016, and many traders are betting there will be further outflows as U.S. interest rates rises make dollar assets more attractive, SAFE wants banks to advise clients to buy yuan and sell dollars, the international bank representative said, a play that is likely to lose clients money. "If a person doesn"t ave this need, how am I supposed to encourage it?" the banker said.

At the same time, SAFE is quietly choking programmes designed to open overseas markets to Chinese investors. Even where institutional investors have been granted quotas to invest overseas, they are finding it increasingly difficult to exchange yuan into another currency.

"SAFE would tell you that you still need to stand in the queue, and the waiting period is "uncertain"," said an executive at Shanghai-based China equity fund house Greenwoods. An investment program set up so global funds can raise Chinese cash to invest overseas has ground to a halt without explanation. "The application process seems to be in a state of suspension," Michael Lu, managing director of Greater China Business Development of Dutch money manager Robeco told reporters in November.

* * *

In short, China has implemented full blown capital controls, without wanting its population to know it has done so, which is understandable: fear of the unknown would lead to panic, would lead to more selling, and more panic and so on. But what we find delightfully ironic is that China is cracking down on the internationalization of its currency, just months after the IMF made the Yuan a fully "respected" member of the SDR - a token of how "liberalized" the currency is. As usual, trust Christine Lagarde to get it dead wrong.

China Warns May Dump Treasuries To Keep Yuan Stable, Prepares More Capital Controls

In China, announcing new (and ever more ineffective) capital controls has become a daily thing.

Last week, Beijing unveiled its latest set of capital controls according to which Chinese banks would be required to report all yuan-denominated cash transactions exceeding 50,000 yuan (around 7,100 US dollars) to the People"s Bank of China (PBOC), down from the current level of 200,000 yuan. Cross-border transfers more than 200,000 yuan by individuals would also be subject to the report process.

Then, overnight, China"s currency regulator, the State Administration of Foreign Exchange (SAFE) added its own round of capital control limitations, when it announced it wanted to close loopholes exploited for purposes such as money laundering and illegally channeling money into overseas property. As a result, while the regulator kept existing quotas of $50,000 of foreign currency per person a year, citizens faced draconian new currency exchange disclosure requirements, requiring foreign currency buyers to indicate how they plan to use the money and when they plan to spend it. Additionally, mainlanders would be restricted from using the FX proceeds to buy overseas property, securities, life insurance or other investment-style insurance products. In fact, among the list of approved uses of funds are tourism, schooling, business travel and medical care. Which means any offshore asset purchases have been effectively limited.

What made the above capital controls especially amusing is that as Xinhua reported over the weekend, "the policy stoked worries that the government is trying to impose capital control in a disguised form." And since the official admission of capital controls would only lead to even more panicked outflows, PBOC economist Ma Jun intervened, saying that the new cash transaction rules, i.e. capital controls, are "not capital control at all."

We leave it up to readers to decide what that means.

Then, fast forward two days when China, no longer bothering with euphemisms, admitted that it has "studied possible scenarios of yuan exchange rate and capital outflows in 2017 based on models, stress tests and field research, and is preparing contingency plans", Bloomberg reported citing people familiar with the matter.

Among the "contingency plans" are proposals recently suggested by such banana countries as Turkey and Venezuela, which include China"s government  asking state-owned enterprises to temporarily convert some foreign-currency holdings into yuan, said Bloomberg"s sources, who are clearly mostly interested in the market"s response to this particular Bloomberg-mediated trial balloon

Bloomberg adds that financial regulators have already encouraged some SOEs to sell FX under current account.

But most troubling is the admission that "China may further cut U.S. Treasury holdings in 2017 if needed to keep exchange rate stable; size of reduction depends on capital outflows and FX market intervention," or in other words, the worst-case scenario which so many serious "economists" have said can not conceivably happen.

Well, China is now actively considering it, which means that should the Yuan continues to slide, Beijing is close to implementing it.

Not unexpectedly, as a result of this latest daily escalation in China"s capital controls, the offshore Yuan is now surging, and is back under 6.95, up nearly 200 pips on the session so far.