Surprising Continuity in Channels for Outflows

China’s State Administration of Foreign Exchange (SAFE) released preliminary data for China’s Q2 2016 balance of payments (BOP) in early August, showing a quarterly current account surplus of $59.4 billion and a financial account deficit of $93.9 billion, resulting in an official $34.5 billion drop in China’s foreign exchange (FX) reserves. The Q2 data indicates continued diversification of household and corporate investments despite capital controls, but at a slower pace than Q1 on reduced external deleveraging. Key points include:

Persistent outflows through direct investment and service trade channels: While media coverage has focused on the slowdown in China’s capital outflows since the early months of 2016, the granular data show a surprising degree of continuity in the most significant channels of those outflows implying household and corporate diversification of assets, including those reportedly targeted via capital controls.

External deleveraging still slowing: The decline in China’s financial account deficit in Q2, based on preliminary data, must be attributable to a slower paydown of external debt, given the larger foreign direct investment (FDI) deficit and the likely continuation of portfolio outflows. Portfolio inflows may improve marginally in Q3, given the persistence of negative yields in many developed markets.

Foreign exchange reserves still falling, but at slower pace: Measures of China’s drain of FX reserves diverged sharply in Q2, with official data showing only a $7.4 billion drop for the quarter, but PBOC foreign assets declined $20 billion and FX settlement data suggested $51 billion in lost reserves. Clearly outflows have eased, but the pace of the drain remains obscured by probable central bank activity in the forwards market.

Posted August 1, 2017
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