2015-02-03

Capital Outflows Intensify As Chinese Drain FX Reserves; Markets > Central Banks

China Sees Biggest Outflow of Capital Since at Least 1998
China’s capital account posted the widest deficit since at least 1998 in the fourth quarter as companies in the world’s second-largest economy increased overseas investment.

The capital account shortfall was $91.2 billion in the three months ended December, the Beijing-based State Administration of Foreign Exchange said on its website Tuesday. The current account surplus shrank to $61.1 billion, it said.

“This signals a shift in China’s economic structure,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. “The expectation of yuan depreciation has appeared and that helped the capital outflow.”
What's driving outflows? Arbitrage, as the offshore yuan is pulling the onshore yuan lower.
A Hong Kong bank foreign exchange trader admitted that the driving force behind it, it intensified the arbitrage the difference between the onshore and offshore renminbi.
Chinese businesses are exchanging RMB for USD in Mainland China and immediately shipping it to Hong Kong in order to buy RMB at the more favorable rate. According to one HK broker interviewed,
"The basic difference between the proceeds will sink more than 80 basis points of the day." He said. This means that if a company invested $ 100 million fund to participate in arbitrage operations, every day at least be able to create about $ 800,000 profit.
This profit opportunity has created a wave of arbitrage trading, leading to the RMB hitting its lower limit over and over again.

This same arbitrage wave happened in 2011/2012. This is also not dissimilar from the interest rate arbitrage wave in spring 2013. Then, fake exports drove a yuan rally as dollar flows moved the other way in order to cash in on interest rate differences. Businesses have seen their margins collapse and instead of conducting normal operations, firms have turned to these type of arbitrage trades. And like the interest rate arbitrage of 2013, these currency trades are evading China's capital controls.

However, due to capital control measures taken within the enterprise to complete these arbitrage operations, no easy task. For example, the large number of dollars to purchase foreign exchange income of how quickly the territory of Hong Kong to sell foreign exchange market is a difficult problem.
Some firms are using Hong Kong subsidiaries to conduct arbitrage and evading taxes in the process. Instead of bringing U.S. dollars onshore, they exchange dollars for RMB in HK, and exchange RMB for dollars in the Mainland.
A trade business executives said, in fact it is not difficult for some domestic enterprises. Their usual practice is to first set up a "window" in Hong Kong, by the company with domestic companies signed a series of trade contracts, will be able to trade under the rapid dollar sinks to achieve arbitrage window company accounts. Even some companies in order to accelerate the speed of the carry trade, let outside window of dollars in the hands of the company will sell the settlement, and then make up the territory of dollars to purchase foreign exchange income gap.

He admits, the benefits of this approach, not only to help companies a lot of "stranded" in the window outside the company's profits tax avoidance, but also taking the appropriate exchange differences gains.
As long as the offshore yuan continues to decline and the PBOC fights the market's pull, there is an unending opportunity for arbitrage. The dollar outflow switch is jammed in the on position.

Some traders wonder if the PBOC will make these trades illegal.
Many banks forex traders not without worry that if the spot exchange rate of RMB and then continued pressing in the limit, do not rule out the central bank may take the exchange rate interventions to curb the behavior of this type of arbitrage.
They aren't worried though, because they believe they are assisting the PBOC in fighting yuan devaluation. If the PBOC needed to defend the yuan in HK, it would have to spend the dollars itself.

Traders believe the onshore RMB reflects the PBOC's desires, while the offshore yuan represents the market and foreign institutions' expectations.
Some degree of refraction of the former Bank of the RMB exchange rate fluctuation range of management's intentions, the latter on behalf of foreign institutions to predict the future direction of the RMB exchange rate movements.
Another good time to review The Informational Power of the Offshore Yuan Exchange Rate

Unlike in the past, today traders believe yuan depreciation is a possibility thanks to the strong U.S. dollar rally.
In the case of the previous few years, unilateral RMB appreciation, even if the exchange differences exist between more than 100 basis points, and rarely trigger poor domestic foreign exchange arbitrage. The reason is that most organizations are more willing to wait for the appreciation of the renminbi to hold gains.

However, with the recent strength of the dollar appreciation and China's economic slowdown, this situation is being reversed rapidly.

He recalled that before the January 26 approaching the lower limit of RMB spot exchange rate for the first time, the Hong Kong dollar against the RMB NDF market than the domestic market offer low 247 basis points, triggering early that day, many enterprises to purchase foreign exchange in the domestic market, then those dollars all transferred to the Hong Kong foreign exchange, cash in exchange differences 247 basis points.

Because of this arbitrage Gouhui disk tide caused the domestic market, the spot exchange rate of the renminbi will soon trigger limit was approaching.

"Since last week, a similar phenomenon has occurred many times." He said that many companies are based on the US dollar overnight index rose to predict the yuan decline in the morning before the day down against the dollar NDF market quotes, widen the yuan domestic foreign exchange difference, then the massive purchase of foreign exchange in the territory, take the dollars and exchange for NDF to lock in exchange rate differences.
As Chinese forex reserves fall, the pressure for yuan devaluation increases. As those expectations are expressed in a lower offshore yuan, this creates arbitrage opportunities. Arbitrage trades drain U.S. dollars from the Mainland, pulling China's forex reserves lower, putting greater devaluation pressure on the yuan. This trend was short circuited in the past because investors expected the yuan to appreciate versus the U.S. dollar. Those expectations have changed.

The PBOC cannot jawbone the yuan higher or pull the market higher by refusing to depreciate the onshore yuan. All that will accomplish is a steady outflow of U.S. dollars that increases the expectations of yuan devaluation.

The market is playing a larger role in the yuan's value thanks to the internationalization of the yuan, but also because the market is relying on the informational power of the offshore yuan, the market priced yuan. Investors are trusting the market more than the central banks all over the globe, and China is no exception.

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