China Eases Capital Controls As Dollar Weakens

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In discussing the key overnight news in an otherwise quiet session, JPM writes that “the most important headline was prob. the one concerning China loosening some currency outflow curbs” so focusing on that, Reuters, and SCMP before it, reports that after months of draconian and ever tightening capital control, China’s central bank has relaxed some of the curbs on cross-border capital outflows it put in place just months ago to shore up the yuan currency.

Specifically, as of last week, the People’s Bank of China (PBOC) is no longer demanding that banks match outflows with equal inflows, the sources said. The South China Morning Post first reported the relaxation of the capital controls earlier on Wednesday.

There was no immediate comment from the People’s Bank of China when contacted by Reuters. The State Administration of Foreign Exchange (SAFE) did not have an immediate response to Reuters’ questions on the SCMP report. While expectations of further yuan depreciation have eased in recent months, opening a window for authorities to relax recent measures, Beijing is not likely to let go totally, said Raymond Yeung, chief Greater China economist at ANZ in Hong Kong. In addition to checking exchange rate expectations, the authorities were also using capital controls to control where Chinese money flows, limiting investments in foreign sectors deemed undesirable, he noted.

“The current macro environment obviously favors an easing of the (rules on) fund flows, but that doesn’t mean that it is going to have solved the structural issue of the mismatch between the corporate desire to go out versus the central government’s centrally-driven approach when they talk about offshore investment,” Yeung said.

This first easing of capital flught measures comes as “China’s leaders and financial markets feel more confident that pressure on the yuan and the country’s foreign exchange reserves has diminished, thanks largely to a pullback in the surging U.S. dollar.” It also comes at a time when increasingly more Chinese companies have complained they are unable to consummate offshore M&A due to the PBOC’s limit on how much capital they can park offshore.

In March the U.S. owner of Dick Clark Productions Inc said that one of its affiliates terminated an agreement to sell assets to Chinese conglomerate Dalian Wanda Group, with Reuters reporting earlier the deal was under pressure amid tight scrutiny by Beijing on outbound deals.

Facilitating Beijing’s decision has been the steep drop in the US Dollar in 2017. As a reminder, the yuan slumped around 6.5% against the USD last year, but has since firmed nearly 1% in 2017, defying many analysts’ expectations of further depreciation, and benefiting from Trump’s recent attempt to talk down the dollar, no matter how hard Mnuchin may try to deny it. Suggesting that Yuan appreciation may just be getting started, a Reuters poll earlier this month indicated investors likely increased their bullish bets on the yuan to the most since July 2015.

Furthermore, with less incentive for capital flight, China’s foreign exchange reserves have clawed back above the closely watched $3 trillion level. Xinhua reported that on Tuesday, Premier Li Keqiang said that market confidence in the yuan has significantly improved.

Still, the small relaxation step won’t help much in terms of outbound investment approvals, said Greg Burch, who works on mid-market China outbound M&A deals as a Hong Kong-based partner at the Locke Lord law firm. “This particular move won’t help on real M&A deals…It’s like the brakes aren’t totally locked up any more, but the foot is still on the brake pedal pretty hard,” said Burch.

On Tuesday, China reported that its non-financial outbound direct investment (ODI) slumped 30.1 percent in March from a year earlier as authorities kept a tight grip on outflows. In the first quarter, it fell nearly 49 percent. While Beijing says it supports legitimate overseas investment, regulators have warned they would pay close attention to “irrational” investment in property, entertainment, sports and other sectors.

China did not spell out what criteria would still be applied to outflows. “Actually, it’ll be the same as SAFE’s previous policy stance, emphasizing that cross-border settlements for legal and compliant business are guaranteed,” said one of the sources, who declined to be identified.

Ultimately, the fate of China’s capital control regime may depend on the outlook for the U.S. currency, which while until recently was expected to rebound as the Federal Reserve continues to slowly raise interest rates, such expectations were put in question yesterday when Goldman ended its long-held bullish dollar call.

But perhaps the best indicator of whether Chinese capital outflows will moderate can be observed in bitcoin, which has been the biggest beneficiary of China’s escalating capital controls over the past two years. As of this morning, BTC was trading at $1,200 just shy of all time highs. As such, at least the electronic currency does not expect major changes in the trajectory or size of Chinese capital flows.