World Economy

China to Counter Record Outflows to Prop Up Yuan

China to Counter Record Outflows to Prop Up YuanChina to Counter Record Outflows to Prop Up Yuan

China will probably have to resort to capital controls as even the world’s biggest foreign-exchange stockpile won’t be sufficient to defend the yuan, according to Societe Generale SA.

If 65 million residents, or about 5% of the population, each took the maximum allowed $50,000 out of China, that would wipe out the $3.3 trillion of reserves, Jason Daw, head of Asian currency strategy at the French lender, said in an interview in Singapore. China needs a stockpile of at least $2.8 trillion to cope with a balance-of-payments crisis, according to Societe Generale estimates based on the International Monetary Fund’s methodology, Bloomberg reported.

“Just because you have the world’s biggest foreign-exchange reserves, the domestic monetary implications of running down your reserves at a rapid pace shouldn’t be underestimated,” Kit Juckes, a global strategist at Societe Generale, said at the same interview. “They have a clear choice: tightening the capital account or allowing the currency to depreciate more quickly.”

Chinese policy makers are trying to counter record outflows and prop up the yuan, while opening up the capital account and keeping borrowing costs low to revive economic growth. The balancing act challenges Nobel-winning economist Robert Mundell’s “impossible trinity” principle, which stipulates a country can’t maintain independent monetary policy, a fixed exchange rate and free capital borders all at the same time.

The yuan has weakened 2.8% since China won reserve-currency status from the IMF at the end of November to 6.58 a dollar in Shanghai, according to China Foreign Exchange System prices. The currency could drop as much as 12% this year to 7.5 if capital outflows intensify, according to a note by Societe Generale’s Daw and Wei Yao, the lender’s chief China economist.

The French bank estimates $657 billion left China in the six quarters through September. Societe Generale is advising clients to stay away from Chinese assets for now and be short on the currencies of Taiwan and South Korea, which count China as their biggest export market. The lender forecasts a 3% drop in the island’s dollar by the end of the year and a 2% decline in the won.

  No Cure

In yet another sign of the strange times, Japan is calling for China to impose controls to stem capital outflows that are eroding the value of the renminbi. This fast-developing orthodoxy that capital controls could give China some breathing room is wrong. Controls would make things worse, not better, FT reported.

China certainly has a problem on its hands. In August 2015, the People’s Bank of China ostensibly freed the renminbi’s value to be more freely determined by market forces. Unfortunately, it got off on the wrong foot, combining a well-intentioned move towards greater exchange rate flexibility with a 2% devaluation relative to the dollar. Financial markets focused on the devaluation, interpreting it as a desperate measure to shore up a stalling economy. The problem was compounded by botched communications.

Since August, China has lost about $320 billion of foreign exchange reserves in trying to prevent its currency from falling too fast. This has intensified a trend of reserve losses since mid-2015 as restrictions on outflows have been eased, allowing households, corporations and institutional investors to seek portfolio diversification through investments abroad.