China is rapidly losing the confidence of global lenders and capital outflows risk turning virulent if the current policy paralysis continues, the world's top banking body has warned.
The IIF, the chief global body for the banking industry, calculates that capital outflows from China reached $US676 billion last year. Photo: Tamara Voninski
"There is a perception that the renminbi could weaken drastically," said Charles Collyns, the managing director of the Institute of International Finance (IIF) in Washington.
Mr Collyns said the authorities had so far failed to articulate a coherent policy, and there were serious worries that outflows of capital could accelerate, broadening into a flood that would be hard to control.
"The Chinese have not been rigorous and they have not been very convincing," he told The Daily Telegraph in London.
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Mr Collyns said China had already allowed the renminbi (yuan) to weaken against the country's new trade-weighted basket of currencies, stoking suspicions that the recent shift from a crawling dollar-peg to a more opaque foreign-exchange regime is really a cover for devaluation.
The IIF, the chief global body for the banking industry, calculates that capital outflows from China reached $US676 billion last year. The central bank has been burning through foreign exchange reserves to offset the bleeding and shore up the currency.
A big drop in the yuan would send a deflationary shockwave through a fragile world economy already on the cusp of a debt-deflation trap, and do so at a time when the eurozone and Japan are actively driving down their currencies.
Mark Tinker, head of equities for AXA Framlington in Asia, said the bulk of the outflows from China were to pay off liabilities.
"Chinese corporates are issuing corporate bonds in record quantities and using the capital to restructure their balance sheets, both onshore and offshore. This is not capital flight, it is asset liability matching, both duration and currency. It is a good thing being presented as a bad thing," said Mr Tinker.
The IIF's Mr Collyns, a former assistant US Treasury Secretary, is less sanguine. He calculates that total dollar debt in China peaked at roughly $US1.5 trillion in late 2014, if all forms of exposure are included.
"We think they have paid off a third of this. Half of the outflows have to repay dollar debt," he said.
"What is worrying is that there could be a broadening of the outflows. There has been a surge in the 'errors and emissions' and this is ominous. A lot of it is below board through inflated trade invoices and other forms of subterfuge, and some of it is ending up in the London property market," he said.
Mr Collyns said there was no guarantee that the outflows would slow, even if all the dollar debt were paid off, since Chinese companies might start taking out "long" positions in the currency markets if they feared that Beijing was losing control.
"The Chinese have to restore confidence by pushing through reforms. There must be greater transparency in fiscal and monetary policy, and they must tackle excess industrial capacity. At the moment they won't impose losses on anybody," he said.
The warnings come as China's $US3.3 trillion foreign reserves fall to the bottom end of the safe band under the International Monetary Fund's measure of reserve adequacy (ARA). These reserves are relatively low by emerging market standards, given that Beijing is trying to defend a semi-fixed exchange rate and do so within a framework of heavy capital flows. The Philippines, Thailand, Peru, Brazil, India and even Russia score higher.
The IMF recommends a band of 100 per cent to 150 per cent of its complex ARA measure.
China is currently near 120 per centpc and almost certainly fell further in January. Societe Generale said the safe level for China was $US2.75 trillion. After that, Beijing will lose operational flexibility. The country has roughly $US600 billion left before it finds itself in a very uncomfortable situation.
"They haven't got as much headroom as people think," said Albert Edwards, the bank's global strategist.
The Daily Telegraph, London