China’s non-FDI (foreign direct investment) capital outflows moderated to about US$59 billion in October, but are expected to continue as U.S. Federal Reserve hikes are likely to lead to a stronger U.S. dollar, says Standard Chartered Bank in a research note.
The trade surplus widened to US$49 billion last month from US$42 billion in September, partially offset by the services trade deficit of around US$27 billion and net foreign direct investment outflows of US$3 billion.
Despite a surplus of US$19 billion under the current and FDI accounts, the People’s Bank of China’s foreign reserve assets declined further by an amount equivalent to US$40 billion in October from a decline of US$51 billion in September, indicating continued net foreign exchange selling by the central bank.
Other indicators also show a slower pace of capital outflows in October. Foreign exchange reserves dropped US$46 billion in October, but excluding valuation changes in the reserve currencies and market-value changes in the reserve asset holdings, the foreign exchange reserves reduction for transaction purposes was less than US$20 billion, indicating relatively light intervention by the Chinese central bank during the month, according to the report.
The easing of non-FDI capital outflows was partly due to a widened goods trade surplus, fewer working days in October, a seasonal decline in foreign exchange demand from the household sector after the peak season in September, and a slowdown in corporations’ hedging of their foreign exchange positions.
Capital outflows since May 2014 have led to a more balanced foreign exchange position in the corporate sector, potentially leading China’s authorities more willing to tolerate Chinese currency weakness against the U.S. dollar, Standard Chartered analysts argue.
Going forward, China’s capital outflows will continue as Fed rate-hiking expectations support a broader U.S. dollar advance. China’s foreign exchange reserves may decrease further on account of the valuation change. However, the authorities may scale back intervention amid broader U.S. dollar strength, using the Renminbi basket to anchor market expectations and exercise capital account control to avoid excessive capital outflows.
Capital outflows have continued to drain liquidity, with China’s M2 growth picking up slightly to 11.6% year-on-year in October from 11.5% in September, still low by historical standards.
The PBoC has become very reluctant to use the reserve requirement ratio (RRR) and may rely on open market operations and medium-term lending facilities to maintain adequate liquidity, as China’s monetary policy turned to a more neutral position from an easing bias earlier this year, the report says.