The State Administration of Foreign Exchange (SAFE) recently released the data on foreign exchange settlement and sales by banks and foreign-related receipts and payments by banks for customers for December 2015. The spokesperson of the SAFE answered press questions on related issues.
Q: What would you say about the cross-border capital flows in China in 2015? What are the characteristics?
A: Overall, China witnessed net outflows of cross-border capital in 2015, but the pressure from outflows in the fourth quarter was lower than it was in the third quarter. Below are the major characteristics:
First, foreign exchange settlement and sales by banks and foreign-related receipts and payments by banks for customers were both in deficit. In 2015, in dollar terms, foreign exchange settlement by banks was down by 9% from 2014, and foreign exchange sales by banks were up by 24%, indicating a deficit of USD 465.9 billion; foreign-related receipts by banks for customers were slightly down by 0.8%, and foreign-related payments by banks for customers were up by 6%, suggesting a deficit of USD 200.9 billion, including a deficit of USD 253.8 billion in foreign-related foreign exchange receipts and payments.
Second, cross-border capital flows fluctuated drastically. For foreign exchange settlement and sales by banks, a deficit of USD 91.4 billion was recorded in the first quarter, which declined to USD 13.9 billion in the second quarter, expanded to USD 196.1 billion in the third quarter and then dropped to USD 164.4 billion in the fourth quarter. For foreign-related foreign exchange receipts and payments by banks for customers, deficits of USD 25.3 billion, USD 1.6 billion, USD 163.7 billion and USD 63.1 billion were posted in the first, second, third and fourth quarters respectively. Net foreign exchange outflows in the fourth quarter were down by 61% quarter-on-quarter.
Third, companies actively repaid domestic foreign exchange loans and cross-border financing and released the risks of high-leverage operation and currency mismatch in an orderly way. The foreign exchange sales rate that measures the motivation for purchasing foreign exchange, or the ratio of foreign exchange sales by banks for customers to foreign-related foreign exchange payments, was 81% in 2015, 12 percentage points higher than it was in 2014, indicating an increasing part of foreign exchange payments by companies was made for foreign exchange purchases while a smaller part was for financing. Accordingly, the balance of domestic foreign exchange loans dropped by USD 100.6 billion in 2015, compared with an increase of USD 21.7 billion in 2014. The cross-border trade finance for imports such as refinancing and forward L/C fell by USD 115.1 billion in 2015, compared with a drop of USD 44.9 billion in 2014.
Fourth, letting people hold more foreign exchange was pushed ahead with and outbound investments by companies for going global were accelerated. The foreign exchange settlement rate that measures the willingness to settle foreign exchange, or the ratio of foreign exchange settlement by banks for customers to foreign-related foreign exchange receipts, was 68% in 2015, 3 percentage points lower than 2014, suggesting companies and individuals were more willing to hold foreign exchange income. While more foreign exchange was used to repay domestic foreign exchange loans and cross-border financing, the balance of companies' foreign exchange deposits as a whole went up by USD 24.9 billion in 2015. The balance of individuals' domestic foreign exchange deposits climbed by USD 18.4 billion, up by USD 13.3 billion than 2014. Chinese companies made ODI of USD 161.4 billion in 2015, up by 90% from 2014.
Fifth, banks posted a deficit in forward settlement and sales of foreign exchange, which dropped significantly in the fourth quarter. In 2015, the value of contracts signed between banks and customers in respect of forward settlement of foreign exchange dropped by 56% compared with that of 2014 and the value of contracts signed between banks and customers in respect of forward sales of foreign exchange went up by 33%, indicating a deficit of USD 194.2 billion. Specifically, the deficit was USD 47 billion in the first quarter, dropped to USD 21.5 billion in the second quarter, expanded to USD 99.3 billion in the third quarter and then fell by a staggering 73% quarter-on-quarter to USD 26.3 billion in the fourth quarter.
Q: What is your view of the recent significant changes in Chinas' cross-border capital flows?
A: The current cross-border capital flows are reflective of the adjustment of the structure of external assets and liabilities in China. According to the data in the International Investment Position, China's net external assets amounted to USD 1.54 trillion as at the end of September 2015. For statistical reasons, this figure is not comparable to that of the end of 2014, but is USD 136 billion higher than the comparable figure of the end of March 2015. Specifically, holders of external assets have shifted from the central bank to market players. As official reserve assets drop, the assets of Chinese market players, such as ODI, securities investments and overseas deposits and loans, have increased, with the figures of the end of September climbing by USD 52.5 billion, USD 8.8 billion, and USD 87.8 billion from the end of March respectively. As for external liabilities, foreign investments in securities and foreign loans in China are dropping, with the figures of the end of September decreasing by USD 180.4 billion and USD 71.5 billion from the end of March. Meanwhile, China's FDI has increased by USD 100.5 billion, indicating continuous inflows of funds for long-term investments.
For the moment, China's balance of payments remains stable, suggesting the risk of cross-border capital flows is within control. First, China continues to post a current account surplus, with the causes and structure of the surplus being reasonable, and still ranks No. 1 worldwide by the size of foreign exchange reserves, which was USD 3.33 trillion as at the end of 2015, much higher than USD 1.2 trillion in Japan, the No. 2 country, and USD 600-odd billion in Saudi Arabia, the No. 3 country. This indicates that the usual payments of the balance of payments are fully ensured. Second, the external solvency risk is in good order and within control. Some companies have recently adjusted their structure of assets and liabilities, leading to a drop of USD 143.4 billion in the balance of external debt at the end of September 2015 from the figure with comparable coverage at the end of March 2015, which is conducive to reducing the risk of repaying external debts in the future. As for solvency, China's external debt critical indictors have been within the international safe standards over the years. For example, as at the end of September 2015, the ratio of full-scale outstanding short-term external debt in both domestic and foreign currencies to the balance of foreign exchange reserves was 29.1%, down by 2.5 percentage points from the end of March and much lower than the international safe standard of 100%. Last but not least, the impact of cross-border capital outflows on domestic liquidity and economic and financial operation is within control.
Q: What's your view of the impact of the Fed's interest rate rise on China's cross-border capital flows? If the Fed continues to slowly raise interest rates in 2016, what changes will occur to China's cross-border capital flows? What will be the mid- and long-term impact?
A: The Fed's interest rate rise will boost the cyclical adjustment of the relevant structure of assets and liabilities of Chinese market players, which is in line with the market law and a necessary phenomenon. Over the past years, as developed economies such as the US adopted QE, emerging economies witnessed large-scale cross-border capital inflows. During this period, Chinese market players also showed a preference for foreign exchange financing to holding foreign exchange assets, which was a reasonable choice in face of unilateral appreciation of the RMB and low cost of foreign exchange financing, but was at risk of excessive adjustment and increased cross-border capital inflows in China. As the Fed recently exited from QE and began raising interest rates, Chinese enterprises adapted to the changes in the environment, optimized the structure of assets and liabilities in domestic and foreign currencies and adjusted the behavior of holding assets in domestic currency and owing debt in foreign currencies that has continued for years. For example, the SAFE statistics show that companies' cross-border financing for imports such as refinancing and forward L/C dropped from the peak of USD 367.4 billion in June 2014 to USD 164.6 billion at the end of 2015, which was equal to the level prior to the Fed's exit from the second round of QE in 2011. This change helped release the external financing risk accumulated by Chinese enterprises as developed economies adopted QE.
The Fed's interest rate rise will pose a challenge to most emerging economies, but China has relatively strong capability to resist the external impact. An analysis of the impact of the Fed's past and recent interest rate rises on emerging economies shows that hard-hit countries are usually those struggling with obviously deteriorated economic fundamentals, continued current account deficit, and heavy reliance on external financing. China's overall economic fundamentals are sound, its economic growth is at the forefront among major economies despite a large economic size, its industrial structure is diversified with great potential, strong resilience, and large leeway, and its financial system is robust. China's balance of payments is stable and healthy, trade in goods and current accounts continue to post a surplus, long-term capital continues to flow in, foreign exchange reserves are abundant, and the marketization of the foreign exchange rate formation mechanism is being deepened.
The Fed's interest rate rise will not upset the basic equilibrium of China's balance of payments in the mid- and long-term. The purpose of this round of interest rate rise by the Fed is to normalize the monetary policy, not to cool the overheated economy, but its direct or indirect impact on the US economy and finance will be taken into consideration, including changes of other economies due to the spillover, which may impact the US instead. As a result, the Fed's interest rate rise may be a slow and cautious process as we expect, the US Dollar Index will fluctuate prior to and post the interest rate hike, and part of the market impact of the interest rate hike may be digested step by step. The normalization of the Fed's monetary policy somehow indicates the promising prospects of the US economic recovery, which will be favorable for stabilizing China's external demand. But it is sure that China's cross-border capital flows are essentially dependent on China's domestic economic fundamentals. In the coming years, as China's economic structure is optimized and upgraded, and the dividends of reform are yielded, China's domestic economy is expected to stabilize and grow after the adjustment is completed, which will strengthen the foundation for the basic equilibrium of China's balance of payments.
Q: China's balance of foreign exchange reserves dropped by USD 512.7 billion year on year as at the end of 2015. Where have these foreign exchange reserves been used?
A: As at the end of December 2015, the balance of China's foreign exchange reserves was USD 3.33 trillion, down by USD 512.7 billion year on year. Many factors have contributed to the changes in China's foreign exchange reserves, such as the Central Bank's operation in the foreign exchange market, the price fluctuations of foreign exchange reserves as investment assets, the changes in foreign exchange rate and support of the "going global" effort by foreign exchange reserves. Major factors are as follows:
First, changes in non-trading value like foreign exchange rate and price led to a decrease of more than USD 100 billion in the book value of foreign exchange reserves, which is different from outflows of foreign exchange from foreign exchange reserves. According to the balance of payments data, in the first three quarters of 2015, foreign exchange reserves obtained from the trading of foreign exchange dropped by USD 227.2 billion accumulatively, while the balance of the book value of foreign exchange reserves fell by USD 328.9 billion, indicating the book value of foreign exchange reserves was down by USD 101.7 billion due to the valuation factors such as conversion of foreign exchange rates. As foreign exchange reserves are denominated in the US dollar, changes in the exchange rates of other currencies against the US dollar will lead to changes in the size of foreign exchange reserves. For example, as the US Dollar Index went up by 9% in 2015, foreign exchange reserves denominated in the US dollar will shrink when non-US dollar assets like the euro in foreign exchange reserves are converted into the dollar.
Second, Chinese market players including companies optimized the structure of domestic assets and liabilities in domestic and foreign currencies, increased foreign exchange deposits and repaid foreign exchange loans. In 2015, corporate and individual foreign exchange deposits in China increased by USD 24.9 billion and USD 18.4 billion respectively, and domestic banks increased USD 102.4 billion in foreign exchange position to satisfy companies' demand for the maintenance of value in the long term. Meanwhile, the balance of domestic foreign exchange loans of companies fell by USD 100.6 billion.
Third, companies and individuals made net payments in foreign exchange such as overseas investments, consumption and repayment of debt. In 2015, non-banking sectors such as domestic companies and individuals made net cross-border payments of USD 253.8 billion in foreign exchange, for ODI, securities investments under QDII, repayment of overseas financing, studying abroad and travel. But huge net inflows of foreign exchange were registered under FDI and overseas securities financing by Chinese companies.
Fourth, as defined by the IMF on foreign exchange reserves, foreign exchange reserves used to support the "going global" effort would be deducted from total foreign exchange reserves when being calculated.
As the economic and financial environments both at home and abroad are still complex and changing, it is normal to see foreign exchange reserves fluctuating. As the formation mechanism for the marketization of the RMB exchange rate is improved, the balance of payments will achieve basic equilibrium and fluctuations of foreign exchange reserves may become a new normal.
Q: China's foreign exchange reserves have been shrinking recently, which have sparked concerns that the liquidity of foreign exchange reserves may be exhausted. What would you say about this?
A: The increase and decrease in foreign exchange reserves are the results of macroeconomic operation. The recent changes in the size of foreign exchange reserves are reflective of the adaptive adjustments of assets and liabilities in domestic and foreign currencies by domestic market players, which send some positive signals, and future changes need to be viewed in a sensible way.
As far as liabilities are concerned, China's external liquidity risk is in a good order and within control. Of the outstanding external debt of USD 1.53 trillion as at the end of September 2015, USD 506.3 billion was mid- and long-term external debt and half of the short-term external debt was trade-related credit. 47% of external debt was denominated in the RMB. Moreover, companies are actively pushing forward deleveraging of external debt. After their balance sheets are recovered, the financial situation will become healthy, which will be more favorable for structural adjustment. The amount of external debt is within the bearable range of foreign exchange reserves, which are more than USD 3 trillion at the moment.
As for assets, companies are the key holders of foreign exchange in the effort of letting people hold more foreign exchange, and they focus on ODI, which has produced significant results in recent years. The International Investment Position data show that the ODI assets of Chinese market players went up by USD 52.5 billion as at the end of September 2015 from the end of March. Individuals purchase foreign exchange mainly for two purposes: first, traveling, shopping and studying abroad, which are the objective results of Chinese economic growth. Second, individuals' wealth management demand to allocate foreign currency assets. Given the real interest differentials between domestic currency and foreign currencies, the benchmark yields of RMB financial products in China still can reach 4%, much higher than the US dollar deposit interest rates and the yields of financial products in other currencies in China, indicating foreign currency assets are not the ideal wealth management channels for Chinese individuals. As for individual use of foreign exchange, no changes have occurred to the policies for purchases of foreign exchange within the quota of USD 50,000 or for purchases of foreign exchange of over USD 50,000 under the current account based on the transaction certificates. Therefore, individuals need to purchase and hold foreign exchange in a sensible way.
Overall, measured by the absolute amount of foreign exchange reserves or by other adequacy indicators such as the shares of foreign exchange reserves in GDP, imports and external debt, China's foreign exchange reserves are abundant, which lays a strong foundation for the state to withstand external impact.
Q: Will the SAFE introduce new management measures in respect of cross-border capital flows? Will measures be taken to restrict purchases of foreign exchange and capital outflows?
A: Given the current situation of cross-border capital flows, the logic that the risk bottom line should be safeguarded while the overall principle of supporting reform and opening up should be followed in foreign exchange administration will remain unchanged. In recent years, under the uniform arrangements of the CPC Central Committee and the State Council, efforts have been made to support the development of the real economy, promote administration streamlining and power delegation, and facilitate trade and investment activities in foreign exchange administration. At the same time, further efforts have been made to strengthen monitoring and early warning of the balance of payments statistics, improve ongoing, ex-ante and macro-prudential management, and enhance offsite verification and onsite inspections so as to guard against unusual cross-border capital flows. This is the direction that has been followed in foreign exchange administration as boosting reform while guarding against risks have been the responsibilities and primary tasks of foreign exchange authorities.
As a result, the principle of supporting and facilitating normal and reasonable use of foreign exchange by market players has not been changed. To prevent drastic fluctuations of cross-border capital, the SAFE has taken some measures, particularly heightened monitoring, standardization of business, crackdown of speculations and irregularities, but no new regulations on restricting purchases and payments of foreign exchange have been introduced. For example, the policy for individual purchases and payments of foreign exchange remains unchanged. The annual quota for individual purchases of foreign exchange of USD 50,000 per person or the equivalent has not been restricted or slashed and such purchases can be done through multiple channels including bank counters, online banking, self-service terminals, telephone banking and mobile banking. Purchases of foreign exchange under the current account of more than USD 50,000 or the equivalent can be handled at bank counters by presenting transaction certificates provided that the transaction background is authentic.
Meanwhile, the requirements for heightening regulation of the authenticity and compliance of foreign exchange receipts and payments have not been changed either. The prerequisites for the facilitation and liberalization of foreign exchange administration remain to be authenticity and compliance. The requirements for authenticity and compliance do not conflict with facilitation. As the demand of the real economy is satisfied and the normal order of the foreign exchange market is maintained, trade and investment facilitation could obtain real and effective guarantee, and benefit the absolute majority of market players. Going forward, foreign exchange authorities will supervise the implementation of the regulatory requirements for authenticity and compliance through offsite monitoring and onsite inspections. Foreign exchange authorities will focus their monitoring and verification on foreign exchange receipts and payments by banks and companies, guide banks to handle foreign exchange business under the principles of "knowing you customer", "understanding your business" and "due diligence" to perform their responsibilities for authenticity and compliance reviews. Moreover, foreign exchange authorities will continue to conduct related inspections of foreign exchange business, crack down on regulatory and legal offences such as fabricated foreign exchange transactions without an authentic transaction background and underground banks.
