It is expected that Beijing will tighten capital controls after the foreign exchange reserves fell by nearly $70 billion due the Central Bank’s policy to prevent the Renminbi from further depreciating due to high capital outflows. According the Institute of International Finance, October was the 33rd consecutive month of net outflow of capital.
Overall, the Renminbi, has been one of the strongest performers amongst currencies in emerging market, but is on its’ worst year since 2005. The Chinese government has attempted to cushion the fall by selling U.S. currency from reserves. The dollar index has risen by 3.1 percent in November among China’s currency basket, and it is thought that the dollar’s rally would have contributed to about half of the decline.
The weakness of China’s currency has contributed to the capital outflows that began at a rapid pace after China devaluated the Renminbi in 2015. According to data, Chinese companies have recorded $121 billion for non- financial outbound investments. The Chinese government is likely reasoned to slow back on such capital outflow because it has allowed investors to move billions of dollars out of the country in light of a slowing economy and currency depreciation. A signal that is being watched closely is the gap between offshore and onshore renminbi exchange rates, as that shows that investors expect further depreciation in the currency’s value.
In addition to capital outflow prevention measures, the Chinese government introduced limits on gold imports and is considering placing restrictions on mergers and acquisitions occurring outside the country that are being disguised as a form of outbound investments. In addition, it is expected that the state council plans to tighten regulations on the acquisition on Chinese companies that acquire overseas companies outside of their core business.
China has one of the most financially leveraged corporate sectors, a volatile property sector, and financial institutions that tend to be reliant on borrowing from the money markets to fund loans for domestic growth. A stronger U.S. dollar along with increasing chances of the rise of interest rates, has fueled the amount of emerging market bonds and stocks. China’s current debt is approximately 250% of the current gross domestic product, and a minor increase in short-term interest rates may lead to debt defaults and less corporate activity, dampening economic growth. Economic analysts’ argue that the default risks are increasing because many corporations rely on the short-term money market to raise the money needed currently to repay existing debt. Due to the increasing capital outflow, the government is in a precarious situation to balance tightening the domestic monetary conditions and allowing for companies to repay their debt.
A strong U.S. dollar appeals to Chinese investors because U.S based assets appear to more attractive when compared to assets backed by a depreciating Renminbi There are increasing concerns due the large amounts of dollar- denominated debt that is currently held by Chinese companies and financial institutions, and a decreasing Renminbi increases the value of a dollar- backed debt. In addition, a rapid decrease in the currency’s value may increase the chances of a short-term interest rates, making the cost of debt more expensive for the most risky members of the financial system.