China Widening Outflows Rather Than Appreciating Currency

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By Chris Shaw

In the view of GaveKal Research one of China’s primary economic policy aims is to reduce dependency on exports as a source of growth by increasing the contribution made by domestic consumption, so the analysts have looked with interest at China’s latest economic data releases to see how the country is performing with respect to meeting this goal.

Here the data is mixed in GaveKal’s view, as while the strong June quarter GDP number shows attempts to boost domestic consumption by the relaxing of policy and via increasing liquidity to the property market are continuing and are having some success, there is evidence of continued currency manipulation in keeping the yuan or renminbi at artificially low levels.

This is clear from the fact foreign exchange reserves increased by US$178 billion in the June quarter as inflows remain very strong, GaveKal suggesting this level of inflows is increasing the risk of extreme money supply growth. The concern is the potential for this to increase inflationary pressures in the economy, which would then require a faster pace of currency appreciation.

Rather than appreciating the currency now GaveKal suggests the current policy approach in China is to try to let off steam by widening outflow channels in its capital account by introducing measures such as allowing companies to keep overseas earnings offshore and eliminating some red-tape to encourage greater overseas investment.

This raises the question of where any benefits from China increasing its outflows will go, the analysts suggesting a number of possibilities including the likes of Taiwan as tourism flows are increasing as relaxed restrictions mean many Chinese are now visiting the island.

Another area where benefits could emerge is in global merger and acquisition activity as Chinese companies try to expand their reach and access to the resources they require. There has already been significant evidence of this in Australia with the Oz Minerals ((OZL)) buy and the proposed Rio Tinto ((RIO)) deal among others and on GaveKal’s numbers Chinese overseas acquisitions are up 26% year-on-year in US dollar terms to US$26.7 billion, with more expected to follow.

Overseas equities and securities could also see a boost as it was only in 2007 Chinese retail investors were allowed to invest in overseas markets. While interest to date has been minimal given this rule change coincided with the blow up in capital markets on the back of the sub-prime crisis, there remains potential for investment in such securities to increase, particularly in the Hong Kong market given its close relationship with the mainland.

US Treasury securities should also continue to benefit as for as long as China continues to build up foreign reserves it has little choice but to invest in such securities given the ongoing role of the US dollar as the global reserve currency, a trend US Treasury International Capital System (TIC) flow data, which measures US transactions with foreigners, clearly shows is still in place.

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