There has been increasing coverage on China’s capital flight problem over the past few weeks. The press love a good story and it has become one after statements by a few well-known hedge fund managers on shorting the Chinese currency have triggered an angry response by Chinese officials. This FT article pretty much captures the mood,
If currency investors were in any doubt over how to characterise the renminbi’s rollercoaster drama last month — a scuffle perhaps, or a skirmish — then China’s ruling Communist Party made it clear: this is war.
Last week the Chinese party mouthpiece, the People’s Daily used a front-page editorial to warn hedge fund manager George Soros off a fight over the renminbi and the Hong Kong dollar in a piece titled “Declaring war on China’s currency? Ha ha”.
So the PBoC is fighting speculators putting pressure on the Yuan peg. No man, no problem.
But, what if those speculators are less important than commonly thought?
Worse, what if “capital flight” has less to do with classic capital flows, i.e. the capital account, but is a result of activities in the “real economy”?
Then fighting those speculators is pointless.
The chart above that depicts China’s gross current account statistics. This is an unusual sight, as we usually only look at the net numbers such as surpluses or deficits. Looking at the gross figures, one can see that the export and import flows (leftmost bars) dwarf the amounts on the capital account side, i.e. those that are labelled “capital flows”. In other words: they are the “real thing”, not the speculators.
The author argues that by looking only at the net number, the trade surplus/deficit for instance, as a proxy for hard currency inflows, one implicitly assumes that all FX earned through exports is converted to the local currency (i.e. leads to an equivalent rise in FX reserves), whereas all exports have to be paid in FX (i.e. are a drain on reserves). This is a big assumption.
There have been rumours of how the Chinese use invoicing tricks to circumvent the capital controls for a long time. Indeed, I have shown in my last post (here), that the use of CNY outside China (offshore deposits) has indeed increased massively over the last five years thereby implying that not all imports have to be paid in FX, but that this is rather a function of appreciation/depreciation expectations.
The author goes on to show how the conversion ratios for imports and exports have developed over the years,
And the result is very interesting (at least for me): around the beginning of 2014 exporters have decided to swap less FX into CNY, just as exporters to China have increasingly insisted on being paid in FX (rather than CNH). Not for nothing have those offshore deposits (see here) peaked around the same time. In short: there must have been a shift in expectations long before the PBOC devalued the CNH this summer.
As I said, pretty interesting; and to a large extent outside the control of the PBOC as it cannot influence the preferences of exporters to China on how they want to get paid.
Now, do I feel more confident that my trade will work out in the near future?
Unfortunately, the answer is no and it has to do with this statement from the above mentioned FT article,
(…) Name me a US hedge fund that isn’t short the renminbi still,” says one Asia-based strategist. “They all have to be — their investors expect it — even if they’re not sure what will happen next (…)
I do not want to sound too cynical, but there is no way that a lot of hedge funds will profit from this trade – markets simply do not work like that.
So I don’t expect a devaluation before 2017…
Disclosure (CNH, AUD)