China Macro:What are the channels of China’s capital outflows?

Measuring capital outflows with Balance of Payment

In 1Q-3Q15, China had US$209bn net inflows under Current Account andUS$437bn net outflows under Capital Account. It resulted in a drop of US$228bnin FX reserves (228 = 437-209). Current Account is easy to understand as it ismostly about trade in goods and services. The goal of this note is to lay out aframework to explain the US$437bn net outflows under Capital Account. Wesummarize it into six channels (in the table below) with the biggest one beingChinese pay down foreign debt”. This note uses the data up to 3Q15. Thedetailed BoP data for 4Q15 will be released on 31 March.

What happened after last Aug?

Depreciation expectation has deteriorated significantly after the fixing reform lastAugust. Examining the six channels of capital outflows, we find that in 3Q15,Chinese increased their foreign deposits substantially while foreignersaccelerated the withdrawal of money from China banks. Error & Omission alsoquickened, suggesting that it disguised some underground capital outflows.

Shall we worry about capital outflows?

depends. Two major forces drive China’s capital outflows: the unwinding ofcarry trade and the RMB depreciation expectation. In the six channels, we don’tworry about the unwinding of carry trade, such as ‘Foreigners withdraw moneyfrom China banks’ or ‘Chinese pay down foreign debt’. After all, China’s foreigndebt is not unlimited (US$1.5tn as of 3Q15). Outflows driven by depreciationexpectation such as ‘Chinese increase foreign assets’ concern us more, though.

Is import misreporting an important channel?

In the note, we also discuss the large discrepancy (over $500bn in 2015) inimports reported by the Customs and by banks. Some view it as a major channelof outflows. However, we find two-thirds of the gap is due to the differences indata coverage by the Customs and banks. Overall, we estimate that at most80bn outflows in 2015 were due to misreporting of the trade. In the six channelsbelow, outflows due to trade misreporting are captured by the Error & Omission.