Q: Could you please provide a briefing on China’s foreign- exchange situation during the first half of 2013?
A: China has seen a transition from an increase in rapid inflows to balanced inflows and outflows of foreign exchange since the beginning of 2013. Foreign-exchange settlements and sales reached USD 911.4 billion and USD 773 billion respectively, resulting in a surplus of USD 138.4 billion during the first half of the year. During the period from January through April, due to the benefits of adequate international liquidity, stable economic fundamentals, and strengthened expectations of an appreciation of the RMB, the trend in large-scale foreign-exchange inflows that emerged during the second half of last October continued, with foreign-exchange settlements and sales at banks registering a surplus of an average of about USD 32.1 billion per month. But due to the changed economic environment in China and the rest of the world, as well due to policy adjustments in China, net inflows of foreign exchange have dropped sharply since May, with the foreign-exchange settlements and sales reaching a surplus of USD 10.4 billion in May but recording a small deficit of USD 400 million in June.
Q: Why was there a slump in net cross-border capital inflows during the last two months?
A: This was due to international, domestic, seasonal, and policy factors.
In the global markets, as the U.S. Federal Reserve announced a gradual withdrawal of the quantitative easing monetary policy after its economic recovery picked up, since May the emerging markets have witnessed a currency depreciation, a decline in the stock markets, and capital outflows. In China, because of downward pressures on its economic growth, those who are bearish on China were on the rise, expectations of an appreciation of the RMB lessened, and forward rates showed the RMB will depreciate more sharply against US dollar; deleveraging reappeared among Chinese firms, and cross-border credit sales and trade financing by banks changed from an average of net inflows of USD 3.3 billion per month during the January-April period to an average of net outflows of USD 21.8 billion per month during May and June. In addition, as the foreign-exchange purchasing price on offshore RMB markets became higher than that on the domestic foreign-exchange market, more purchases of foreign exchange were made in the Chinese mainland, and RMB net payments under the trade item fell from a monthly average of USD 10.9 billion during the January-April period to USD 5.1 billion during May and June. All of the above factors contributed to the decrease in the surplus in foreign-exchange settlements and sales by banks.
In terms of seasonal and policy factors, since May and June are peak seasons when Chinese residents choose to travel or to begin their studies abroad, as well as seasons when most foreign-funded firms distribute their bonuses, average monthly purchases of foreign exchange for overseas tours and for investments rose 16 percent and 83 percent respectively from the January through April period of this year. During the past few months, government departments, including the People’s Bank of China, the General Administration of Customs, the China Banking Regulatory Commission, and the State Administration of Foreign Exchange (SAFE), have introduced policies and measures to regulate the settlement of cross-border trade in RMB and customs declarations for exports and to enhance management of bank wealth management products and foreign- exchange inflows, and have managed to contain capital arbitrage via false trading in liquidity.
Q: Most emerging markets have been under pressure from currency depreciations and capital outflows during the past months. I am wondering whether China is at risk of continuous large-scale cross-border capital outflows during the second half of the year.
A: As the U.S. Federal Reserve is expected to gradually increase its exit from quantitative easing that began in May 2013, there have been signs that this may lead to gradual withdrawal of foreign capital from the emerging markets, with a decrease in the MSCI Emerging Markets Index and the currency indices by more than 10 percent.
So far, no signs of massive foreign-capital withdrawals have been discovered in China. First, FDI and net cross-border capital inflows in securities investments have continued to rise. In June, net FDI inflows totaled USD 11.9 billion, up by 14 percent month on month, and net foreign-exchange settlements for securities investments totaled USD 1.5 billion, 3.5 times that during the previous month. Second, FDI withdrawals have remained at a low level. Foreign- exchange purchases for FDI withdrawals totaled USD 3.5 billion during the first half of the year, down by 17 percent year on year. Third, there have been only slight changes in the investment profits repatriated by foreign-funded firms. Foreign-funded firms usually distribute bonuses around June of every year. During this June, profits repatriated by foreign-funded firms dropped 2 percent year on year to reach USD 12.6 billion.
Given the uncertainties and instabilities in China and the rest of the world, it is expected that during the second half of the year China’s cross-border capital will stabilize amid fluctuations. As global economic growth continues to slow down, China’s overall external demand will remain weak while international trade frictions will increase, thus placing heavy pressure on exports. As most people believe that the RMB exchange rate is currently at an equilibrium, higher two-way volatility and weaker expectations of an appreciation of the RMB are favorable for slowing down capital inflows. In 2012, for example, China saw bi-directional changes in cross-border capital flows. This pattern of cross-border capital flows and the balanced supply and demand for foreign exchange will become more common in the future, so adaptive adjustments will be made to both domestic macro controls and to the behavior of domestic market players.
During the next phase, the SAFE will focus on strengthening the monitoring of cross-border capital flows, increasing policy and data transparency, improving contingency plans and policies to limit the impacts of two-way cross-border capital flows, and will do whatever it takes to control risks in order to support a balance in the balance of payments and the sustained healthy development of China’s foreign-related economy.
Q: What about the increase in the foreign-exchange positions of the banks after the SAFE introduced measures to strengthen administration of foreign-exchange fund inflows?
A: On May 5, the SAFE issued the Circular of the SAFE on Relevant Issues on Strengthening Administration of Inflows of Foreign- Exchange Funds (Huifa [2013] No. 20, referred to as Circular No. 20 hereafter), stating that a bank’s minimal consolidated position in foreign-exchange settlements and sales will be linked to the foreign-currency loan-to-deposit (LDR) ratio. Banks whose foreign-currency LDR ratio exceeds the reference rate can reduce their LDR ratio via decreasing foreign-currency loans and increasing foreign-currency deposits, or via buying foreign exchange on the spot market and increasing its position through forward foreign- exchange trading. As the policy allows for a two-month transition period, since its issuance the influence of this circular has been absorbed by the financial market, and the foreign-exchange market has remained stable.
The overall consolidated position of banks at the end of June was USD 22.5 billion more than that on May 5, the day on which Circular No. 20 was issued, and it was higher than the amount that Circular No. 20 required to be increased. Further analysis shows that net outstanding forward foreign-exchange settlements registered an increase of USD 23.8 billion, while the decrease in the banks’ positions on a cash basis was USD 1.3 billion during the same period, suggesting that forward foreign exchange was not traded thoroughly flat on the spot market so that banks could meet the requirements of Circular No. 20 to increase their consolidated positions. Circular No. 20 has had a limited impact on the banks’ domestic- and foreign-currency cash positions.
