A History of Chinese Capital Control since 1990s

Ignore this post. Rather, see another post written in 21, Aug.

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1. In early 1990s, there was a devaluation of CNY. But, the negative effects were to Chinese workers mainly, because they had no investment vehicle such as stock market or private bond market to protect the risk from inflation. Deposits were officially limited by the state, as well.

2. By 1994, China had a major inflation problem in line with launching the government-led projects. But, they couldn’t stop those because of the fear of mass unemployment.

… Economic reforms were coming.

3. So, by mid 1990s, China began to introduce export oriented model including the openness of capital account to foreign direct investments. One is the most important was China adopted pegging CNY to USD. And then, mega inflation promptly eased.

4. Many Asian countries, from Hong Kong, Korea, Taiwan to Malaysia, adopted the export-led economy which succeeded in Japan, however, as known as, they suffered from the financial crisis in late 1990s. The only one difference of them and China was pegging local currency to dollar or not. China compeletey controlled their capital account.

5. By 1998, the strategy was working. Exports were greater than imports due to the impact of weaken real effective exchange rate.

6. Meanwhile, the trade partners with China hardly took any benefit as China absorbed all of excess dollars from trade with FX purchasement. So, the world was upset. China broke WTO rules as well.

7. But, main developed markets which had high-cost industrial environments should use cheap factories in Chinese economy. So, FDI flowed into China. This was an essential selection for corporations in western society to remain their competitiveness. They were Japan, US, and Europe.

8. China had to maintain its direction of relatively weak CNY because they should face the emergence of bubbles in asset markets, especially in property market. It suggested a signal that Renminbi value would remain to market participants. In fact, if PBOC stopped FX purchases, individuals would increase their spending and this could decrease the competitiveness of exports side.

9. By 2004 to 2005, the amount of FX reserves in PBOC, consist of USD mainly, were sufficient to defend long-end US treasury yield from rising higher, as known as a conundrum with monetary tightening cycle, as China should buy USD assets especially long-end treasury bonds to use their reserves.

10. They invested US government sponsored enterprise paper, GSE, including Fannie and Freddie. Chinese investments could lead lower cost of borrowing for those, and the residential market bubble in US had grown.

11. At the same time, China decided to start economic rebalancing to boost domestic consumption. To help achieve this, it should begin to appreciate RMB.

12. As a result, the world started to recognize China as the biggest consumption powerhouse and the commodity super cycle began.

13. As Chinese FX reserves increase rapidly, China set the soverign wealth fund, Chinese Investment Corporation, to diversify their FX in 2007. And in 2007, premier Wen Jiabao allowed for Chinese individuals to start investing in Hong Kong markets, and expanded toward US by 2008.

14. And in 2008, as you know, it happened…

15. As a result, US and other western economies started to reform their economic structures as decrease low-value jobs and increase competitiveness of luxury good, service, arts and high tech sectors.

16. After late of 2008, the commodity market bursted, so China felt need to rebalance. They set the tri-value RMB system made up of onshore CNY, offshore CNH, and non-deliverable forward (NDF, USD setteled) market in 2009.

17. But, they wanted to maintain their dual mandate which was both of export-oriented modle and economic rebalancing. So, they decided to increase expenditures worth of about 4 trillion dollars to boost social welfare and infrastructures rather than led market liberalization. This meant increasing debts.

18. That said, they had not to give up the appreciated RMB, so domestic institutions tried to use leverage of USD for investments in RMB assets.

19. On the early stage, they use the commodity stock as a collateral to borrow dollars to reinvest in higher-interest shadow banking vehicles at shorter duration. But, after continued collapse in commodity price, they started to use trade invoices and gold, especially in 2013.

20. Chinese government warned those institutions as devalue RMB unexpectedly in 2014. And there was somewhat capital outflow from China. One of this outflow was from domestic corporations used leverage investments, which meant deleveraging, while another one was from foreign FX lending positions due to the fear of conditions in Chinese industries.

21. Chinese companies seemd to be suffered from the burden of debts increased especially from 2008 to 2010, in line with government’s economic boosting policies. And as capital outflow continued, the monetary conditions tightened and banking system was to be vulnerable.

22. So, PBOC should start to cut both of RRR and base interest rate in late 2014.

23. And for now, China seems to want CNY to include into SDR in IMF. It wil likely stabilize CNY value in longer term.

24. Meanwhile, FDI in China doesn’t look bad. During 7 months in this year, FDI increased 7.9%, a worth of 76.6 bn dollar.

25. Chinese government may was afraid of possible shock with additional deleveraging and capital outflow rapidly which could start with US Fed’s rate hike could lead stronger dollar than now. If then, inclusion into SDR of CNY would be difficult for now.

26. If this analysis is correct, the fear of devaluation of CNY or capital outflow from China would be overstated, because both of them are all Chinese government’s intensions.

27. On the other hand, remaining amount of leverage position, as know as a carry trade, is difficult to estimate, so this would be a risk in short term. Market would continue to suspect Chinese government’s ability to handle this.

28. But, in mid term or longer run, this could stabilize Chinese capital account as open the market to get investments from overseas through liberalization and inclusion into SDR.

(Thanks to FT Blog... I couldn't write the daily summary yesterday due to studying this...)