Efficacy of China‘s capital controls
RIETI/BIS/BOC conference
Globalisation of financial servceis in China: implications
for capital flows, supervision and monetary policy
Beijing, 19 March 2005
Guonan Ma and Robert McCauley
Bank for Intenational Settlements
1
Agenda
I.
China‘s capital account is leaky:
1. Expanding gross cross-border flows
2. Non-FDI capital inflows: main sources of reserve accumulation
3. Bank flows responsive to yields and currency expectations
4. Leaks through leads/lags in trade payments
II. But China‘s capital controls bind:
a. Big onshore/offshore yield spreads
b. Signs of the spreads suggest underlying pressure on curerncy
when capital controls bind
c.
China retains independent monetary policy in the short run
2
I. 1. China’s rising gross cross-border flows
China’s gross cross-border flows1
Graph 1
As a percentage of GDP
100
100
Gross current account flows
Gross capital account flows
80
80
60
60
40
40
20
20
0
1
1982
1990
0
2003
Defined as the sum of debit and credit flows on China’s balance of payments, excluding errors and omissions.
Source: CEIC.
3
China’s rising gross cross-border flows
z The sum of all the BoP debit and credit flows as a
proxy for the size of gross cross-border flows
z Gross cross-border flows via both current and capital
accounts have increased significantly:
¾ 100% of GDP in 2003 vs. less than 20% in 1982
z Gross cross-border capital flows have expanded faster
than gross current account flows:
¾ Possible underestimation of cross-border bank flows
z Larger cross-border flows set the stage for a leaky
capital account and limited efficacy of controls
4
I. 2. Major sources of China’s rapid
reserves accumulation
z Official foreign reserves accumulation accelerated to
record $207 billion during 2004
– Equivalent to 13% of GDP!!
z Big reserves build-up was fuelled mainly not by basic
balance surpluses but by net non-FDI capital inflows:
Basic balance = current account + net FDI balance
z Basic balance surplus funded all FX accumulation in 2001
and 2002 but only half of the buildup since 2003
5
Non-FDI inflows versus basic balance surplus
Graph 2
China’s basic balance, non-FDI capital flows and reserve accumulation
In billions of US dollars
100
100
80
Reserve accumulation1
Basic balance2
Non-FDI capital flows
80
60
60
40
40
20
20
0
0
–20
2001
2002
2003
2004
–20
1
Adjusted for valuation effect and the $45bn bank recapitalisation in 2003H3. 2 Sum of current account balance (adjusted for net current
transfers) and net FDI balance. 3 Includes net current transfers and errors & omissions.
Sources: CEIC; BIS estimates.
6
Leaky capital controls: unusually large
inflows in remittance and error flows
Graph 6
China’s balance of payments: net current transfers and errors and omissions
In billions of US dollars
20
20
Net current transfers
Errors and omissions
10
10
0
0
– 10
– 10
– 20
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
– 20
2003
Source: CEIC.
7
Adjusting China’s basic balance
z Unusually big swings in net remittances and net
error/omission flows
–
suggest a leaky capital account and
–
distort the relative role of non-FDI capital flows
z The need for adjusting the basic balance and non-FDI
capital flows:
1) Adjusted basic balance = current account + FDI – exceptional net
remittance
2) Adjusted net Non-FDI capital flows = non-FDI capital flows +
exceptional net remittance + net error/omission flow
8
I. 3. Bank flows sensitive to relative yields
and expected exchange rate
z Dollar bank deposits and loans respond systematically to
relative yields and currency expectations:
– After the Asian crisis, Chinese residents added $ deposits and
trimmed $ loans, because of lower RMB yields and depreciation
expectations
– Since 2002, they stopped adding $ deposits and took more $ loans,
owing to higher RMB rates and appreciation expectations
z These responsive dollar bank flows
– reflect active underlying cross-border capital flows
– affect the pace of reserves accumulation
9
Dollar deposits sensitive to relative yields
Graph 4
China’s foreign currency deposits and relative dollar deposit yields
10
400
1-year USD/RMB deposit rate less 1-year RMB deposit rate
(lhs, in basis points)
Ratio of foreign currency to RMB deposits
(rhs, in per cent)
300
9
200
8
100
7
0
6
–100
5
–200
1999
2000
2001
2002
2003
4
2004
Note: The onshore dollar deposit rate is for small deposits (USD 3 millions of less).
Sources: The People’s Bank of China; authors’ own estimates.
10
Since 2002, strong demand for dollar loans
while weak dollar deposit holdings
Graph 8
Foreign currency loans and deposits at banks in China
In US$ billions; end-of-period figures
160
150
160
Loans
Deposits
150
140
140
130
130
120
120
110
110
100
100
90
1998
1999
2000
2001
2002
2003
90
2004
Note: Data for 2004 refer to June.
Sources: The People’s Bank of China; authors’ own estimates.
11
BIS area banks report active crossborder bank flows in China
z These shifts in dollar deposits and loans have been
partially accommodated or financed by banks in China
drawing down their net overseas claims on BIS banks
– Both Chinese and foreign-owed banks in China
z In 2002 and 2003, China’s net claims on BIS banks
shrank by almost half (territorial data) =>
– Overseas claims fell by 10%
– Overseas borrowings rose by one third
12
Rising claims and falling liabilities
of BIS banks vis-à-vis China (US$ bn)
120
30
20
100
10
80
0
-1 0
60
-2 0
40
-3 0
N e t c la im s o n C h in a (R H S )
-4 0
C la im s o n C h in a (L H S )
20
-5 0
L ia b ilitie s v s C h in a (L H S )
Q3 2003
Q4 2002
Q1 2002
Q2 2001
Q3 2000
Q4 1999
Q1 1999
Q2 1998
Q3 1997
Q4 1996
Q1 1996
Q2 1995
Q3 1994
Q4 1993
Q1 1993
Q2 1992
Q3 1991
Q4 1990
-6 0
Q1 1990
0
13
I. 4. Capital flows leak through China’s
large, more liberalised trade sector
z “Leads and lags” in trade payments may produce cross-
border capital flows of $193 billion, given
– Accelerated export receipts & delayed import payments => capital inflows
– China’s exports and imports total $1,155bn last year
– A two-month shift in export receipts or import payments
z These potential trade-related capital flows are equivalent to
– 32% of China’s official foreign reserves ($610bn at end of 2004)
– Nearly 100% of China’s reserve accumulation in 2004
14
II. Despite leaks, China’s capital control
still effective and binding
z A better measure: cross-border arbitrage conditions
z Capital control reduces capital mobility
z Said to be effective when interest rates on same currency differ
onshore and offshore
z Covered interest parity rests on free capital mobility and market-
based interest rates:
RMB forward premium (annualised)
= RMB interest rate - USD interest rate
15
Implied offshore RMB interest rate
z In presence of effective capital control, onshore and
offshore markets segment and yields differ
z Implied RMB interest rate abroad = USD interest rate
abroad – offshore RMB forward premium
F = S (1+r)/(1+r$),
where
F = Offshore RMB forward rate (measured by NDF)
S = Spot RMB/USD rate
r$ = USD LIBOR
r = NDF implied RMB interest rate offshore
16
Capital controls: effectiveness and
direction of market pressure
z When onshore yields on RMB ≠ offshore NDF-
implied yields on RMB, markets in the same
currency are segmented
z The size and sign of the gap between onshore RMB
yield and NDF-implied offshore RMB yield suggest
– Effectiveness of capital control
– Direction of market pressure
17
Large onshore/offshore spread for the RMB
z The cross-border yield
spread on RMB averages
250-300 bps
z The RMB spread is the
second largest in Asia for
the 2002-2004 episode
z By comparison, the Korean
won counterpart is only 50
bps for the same period
18
Feb.04
Dec.03
Oct.03
Aug.03
Jun.03
Apr.03
Feb.03
Dec.02
Oct.02
Aug.02
Jun.02
Apr.02
Feb.02
10%
Dec.01
14%
Oct.01
Aug.01
Jun.01
Apr.01
Feb.01
Dec.00
Oct.00
Aug.00
Jun.00
Apr.00
Feb.00
Dec.99
Oct.99
Aug.99
Jun.99
Apr.99
Feb.99
Dec.98
Evolving onshore and offshore RMB rates
18%
16%
O f f s h o r e 3 m N D F - im p lie d
12%
O n s h o r e 3 m C h ib o r
8%
6%
4%
2%
0%
-2 %
-4 %
-6 %
-8 %
19
Onshore less offshore spread has
been positive since 2002
1 ,0 0 0
800
600
S p r e a d b e t w e e n 3 m o n s h o r e y ie ld
a n d o f f s h o r e N D F - im p lie d y ie ld
400
200
0
-2 0 0
-4 0 0
-6 0 0
-8 0 0
Feb.04
Dec.03
Oct.03
Aug.03
Jun.03
Apr.03
Feb.03
Dec.02
Oct.02
Aug.02
Jun.02
Apr.02
Feb.02
Dec.01
Oct.01
Aug.01
Jun.01
Apr.01
Feb.01
Dec.00
Oct.00
Aug.00
Jun.00
Apr.00
Feb.00
Dec.99
Oct.99
Aug.99
Jun.99
Apr.99
Feb.99
- 1 ,2 0 0
Dec.98
- 1 ,0 0 0
20
Signs of spread indicative of
directions of market pressure
z Before mid 2001, implied RMB interest rate offshore was higher
than onshore rate, suggesting capital controls effective in
limiting capital outflows
z Now offshore RMB interest rate is lower, suggesting capital
controls effective in limiting capital inflows into RMB assets
– restrictions on the accumulation of RMB assets funded by dollar
liabilities
– even more net dollar sales against RMB to the PBOC in the
absence of effective capital control
21
Domestic CNY yields less USD yields
bps
800
700
3m Chinese repo less 3m US Treasury
600
PBC base lending rate less effective Fed fund rate
500
3m CHIBOR less 3m LIBOR
400
300
200
100
0
-100
-200
-300
-400
Ju
n.
9
S 7
ep
.9
D 7
ec
.9
7
M
ar
.9
8
Ju
n.
9
S 8
ep
.9
D 8
ec
.9
8
M
ar
.9
9
Ju
n.
9
S 9
ep
.9
D 9
ec
.9
9
M
ar
.0
0
Ju
n.
0
S 0
ep
.0
D 0
ec
.0
0
M
ar
.0
1
Ju
n.
0
S 1
ep
.0
D 1
ec
.0
1
M
ar
.0
2
Ju
n.
0
S 2
ep
.0
D 2
ec
.0
M 2
ar
.0
3
Ju
n.
0
S 3
ep
.0
D 3
ec
.0
M 3
ar
.0
4
Ju
n.
0
S 4
ep
.0
D 4
ec
.0
4
-500
Source: CEIC.
22
Table 2
Relations among interbank market rate pairs
7 days
3 months
CNY/USD
EUR/USD
CNY/USD
EUR/USD
Ave of absolute difference (bps)
152.7
142.1
271.2
276.9
Max of the differential (bps)
173.4
190.0
783.5
166.4
Min of the differential (bps)
-429.6
-281.5
-435.2
-283.8
Correlation coefficient
0.405
0.657
0.591
0.744
Note: The interbank market offer rates are CHIBOR for the renminbi, LIBOR for the US dollar and EURIBOR for the
euro; monthly data from January 1999 to February 2005.
Source: CEIC.
23
Summary
z China’s gross cross-border flows rose significantly; non-DFI capital
inflows fuelled half of the latest reserves accumulation
z Recent big swings in capital flows via the current account (such as
remittance and leads/lags in trade payments) by Chinese residents
to put on short-dollar, long-RMB positions
z Large cross-border bank flows responsive to relative yields and
indicative of a leaky capital account
z Arbitrage fails to equalise yields, suggesting effective capital
controls that have limited cross-border capital flows and
segmented onshore and offshore markets
z China enjoys no less monetary independence than the euro area
z China’s capital account is leaky, but its capital controls still bind
24