Promoting Efficient Cross-Border Capital Flows
In 2015,heavy capital outflows damaged the Chinese economy and threatened financial stability. In 2016,the outlook for cross-border capital outflows remains unclear as downward pressures on capital inflows continue. China's central bank has a number of tools to support the currency,which remains under selling pressure on global markets. Policy makers should make greater use of these tools and guide expectations of the renminbi's exchange rate while they strengthen regulations on abnormal capital movements and enhance the role of exchange rate policy in financial regulations.
At the same time,we need to reassure the markets by implementing promised reforms. Specifically,we should strengthen the foundation for sustainable,long-term growth through structural supply-side reforms. This is the key to stimulating efficient cross-border capital flows.
Continued Pressure from Capital Outflows in 2016
Since the second half of 2015,expectations of increases in interest rates by the Federal Reserve have been building. At the end of last year,the U.S. central bank did what the markets had been anticipating and made its first rate hike. That had a significant impact on the global economy and the world's financial system. Emerging markets have been buffeted by currency depreciation and market turmoil while outflows of capital have increased. That has led to further slowdowns in emerging market economies. Meanwhile,China's economy has endured increasing downward pressure and its capital markets have also been subjected to great volatility. After the reform of the currency on August 11,2015 -- a move that was in effect a devaluation -- speculation of another devaluation of the renminbi against the dollar took hold. Against this backdrop,capital outflows from China have been increasing.
China's international balance of payments position has clearly demonstrated the changes in capital flows. According to data released by the State Administration of Foreign Exchange in February,China's current account surplus in 2015 rose 33% to a total of $293.2 billion,indicating an increase in cross-border capital inflows under the current account. However,the capital account,excluding reserves,showed a deficit of $504.4 billion,indicating huge capital outflows.
Foreign exchange reserves stood at $3.3 trillion,down 13% from a year ago,indicating a net capital inflow. Net "errors and omissions" were $132.1 billion,implying sizable,abnormal cross-border capital flows that other data failed to capture. In general,the non-reserve capital account tally and "errors and omissions" roughly reflect the cross-border capital outflows. The sum of these two figures shows that in 2015 net capital outflows reached approximately $630 billion.
In my opinion,the outlook for China's cross-border capital flows in 2016 is still cloudy. China still faces pressure from net outflows,though the outflows may ease. In terms of the overall international balance of payments,there is likely to be a surplus on the current account and a deficit on the capital account.
The surplus on the current account will probably reflect a number of factors. The global economy continues to recover and China's exports are expected to remain stable under the "One Belt,One Road" initiative,which envisions greater bilateral and multilateral cooperation. International commodity prices will remain at low levels. Import prices are unlikely to rebound though import demand from China is likely to hold fairly steady. Therefore,China's merchandise trade will probably show a surplus. However,due to China's increasing demand for overseas study,travel and shopping,the deficit in the services trade may widen. Overall,the current account surplus may show a decline in terms of its size in relation to the GDP.
Net direct investments will continue to decline. In 2015,China's net direct investment fell by 63% to $77.1 billion,as a result of rapid growth in outbound direct investment and stable growth in inbound foreign direct investment. In the future,as China proceeds with its "One Belt,One Road" strategy and domestic firms speed up their efforts to expand into the global market,net direct investments should shrink and eventually China will become a net exporter of capital.
The outlook for net foreign investment in China's securities market is uncertain,but the overall impact of this segment of capital flows is limited. In 2015,due to the devaluation of the renminbi and the high volatility on domestic capital markets,net foreign investment in Chinese securities was negative,reversing the positive tally of the previous year. During the first three quarters,China's purchases of foreign stocks and bonds through programs such as the Shanghai-Hong Kong Stock Connect -- which links the two exchanges -- and the qualified domestic institutional investor program (QDII) -- which channels funds for securities investments offshore -- increased by $57.3 billion. But foreign purchases of Chinese securities through the Shanghai-Hong Kong Stock Connect,the qualified foreign institutional investor (QFII) and renminbi qualified foreign institutional investor (RQFII) programs -- which channel inbound investments -- shrank to $16.1 billion. In total,the net outflow was $41.3 billion. Net capital outflows may be reduced this year as corrections in the domestic stock market have been largely completed,the QFII quota has been increased and speculation on a depreciating currency has eased. If these trends continue we could even see a return to net inflows in this area. However,capital flows through these channels account for only a small portion of the total cross-border movement of capital.
Meanwhile,capital outflows through other channels remain at reasonable levels. In 2015,the largest capital outflows were through channels such as deposits,cross-border loans and trade credits. In the first three quarters,the total capital outflows through these channels surged to $330.4 billion-- triple the level of a year earlier. These capital flows are driven by domestic banks and companies increasing their foreign assets or repaying foreign debt. This is a proper response by banks and corporations against a background of speculation on a further depreciation of the renminbi and higher interest rates in the U.S. In 2016,the top two drivers of capital outflows from China were expectations of a weaker domestic currency and an impending rate hike by the Fed. In my opinion,the global turbulence has already slowed the pace of the Fed's plans to raise rates further. Additionally,any further depreciation of the renminbi is likely to be limited. Capital outflows driven by these two factors will therefore be reduced.
Proper Controls
Overall,the impact on the financial system from capital outflows from China can be controlled as we still have a current account surplus,there are large foreign exchange reserves and pressure for the repayment of long-term debts remains modest. Currentl