More Bad News Out of China, Including massive Capital Flight

Reader Michael sent a host of updates on China, which might collectively be called, "Lousy China News Wrap." And I don't think he was cherry picking

The eye-catching one was a coded story on capital flight from China, "China warns of risks from "abnormal" cross-border capital flow," from Xinhua. The reason that capital is exiting China now is that a lot of hot money came into China in 2008 to take advantage of a widely expected RMB apprecation (yours truly also thought the RMB was a one-way trade, but somehow managed not to act on it). Brad Setser and Michael Pettis have both watched the influx of speculative funds with considerable alarm, but the issue has not gotten traction in the media.

Pettis and Logan Wright wrote a Financial Times comment in July that gave a good overview:

During the first halves of 2005 and 2006, the trade surplus, FDI and estimated interest on China’s reserves accounted for 80-90 per cent of the country’s reserve accumulation. In the first half of 2007, these components accounted for about 70 per cent. This year, however, their share has declined dramatically to 39 per cent from January to May....Because there are likely to be speculative inflows buried in the trade and FDI accounts, their true share is probably even lower.

So what is powering China’s accelerating reserve accumulation? Probably hot money....more and more investors, business people and ordinary households are bringing money into China to take advantage of profits associated with the expected appreciation or to protect themselves from the losses they will incur with the rising renminbi...

There is no technical definition of hot money ....but it is possible to obtain rough proxies...In every case the proxy...shows a startling increase over the past 12 months. The fact that in recent months the authorities have taken increasingly desperate measures to staunch the inflows confirms this interpretation of soaring hot money proxies....

Hot money is notoriously unstable and even more notoriously procyclical. When the economy is growing, or even overheating, inflows are likely to increase net investment and add even more fuel to the economic engine. But when conditions change and the economy begins to slow or the country face financial risks, hot money is likely to flee the country, exacerbating the very conditions it is fleeing.

With this background, the importance of Xinhua story is more apparent:

China faces a threat of "abnormal" cross-border capital flow because of global financial tumult, the country's foreign exchange regulator said Tuesday...

More money flowing out of the border could increase the risk of liquidity strain in the country, which is especially dangerous amid the global financial crisis...

China's foreign exchange reserves had fallen for the first time since December 2003, Cai Qiusheng, a SAFE official, told a conference last month. He didn't give specific data of when that happened or by how much.

He said the current reserves were below 1.9 trillion U.S. dollars, the level recorded at the end of September. It was the largest reserve in the world.

The SAFE will improve management on fund flows in and out of the border and more closely monitor the balance of payments, said Hu.

He urged for better risk control in managing foreign exchange reserves, which was "the last safeguard" against risks.

China's central bank said Tuesday it will also strengthen scrutiny of cross-border capital flows and study ways to tackle "abnormal changes" in the balance of payments.

The People's Bank of China said it will check the validity of trade payments and step up supervision on individuals carrying foreign currencies in and out of the country.

I would assume "strengthen scrutiny of cross border capital flows" means "tighten foreign exchange controls even further."

And separate from the flight of hot money, we may be seeing a reversal of FDI investment as newly needy multinationals unload their stakes in Chinese companies to shore up their balance sheets, as Bank of America has. From Reuters:

Top U.S. lender Bank of America raising cash to weather a dismal market at home, is selling a $2.83 billion chunk of its holding in China Construction Bank (0939.HK: Quote, Profile, Research, Stock Buzz) at a 12 percent discount on Wednesday, according to a term sheet obtained by Reuters.

The U.S. lender was selling more than 5.62 billion shares, or nearly 13 percent of its holding in Construction Bank, at HK$3.92 apiece, in a placement that had been widely anticipated.

The stake represents about 2.5 percent of Construction Bank, and will leave Bank of America with a 16.6 percent holding in the Beijing-controlled lender once the sale is completed.

"The news has been expected but investors will still take it hard because BoA will most definitely sell more. They need the money," said Francis Lun, general manager with Fulbright Securities in Hong Kong.

ChinaStakes gives an update on the Chinese housing market that makes the US seem almost balmy. Note that in China, consumers mortgages are not common and even when they are used, loan to value ratios are very low, so a fall in real estate prices does not lead to the sort of large scale foreclosures that we see here. However, Chinese banks are very exposed to developers, and the article discusses how a very high percentage of new development is unsold (enough to constitute a three year overhang in Beijing, for instance). China's central bank last fall forecast a 10% to 30% fall in real estate over the next two years (and recall this is an even bigger decline in real terms, since China still has a high inflation rate) and warned of resulting liquidity problems for real estate companies and banks.

From ChinaStakes:

For those who have worked in the Beijing real estate industry over the past 10 years, 2008 has been the worst. Latest figures revealed by the Beijing Bureau of Statistics show that housing sales area between January and November totaled 7.389 million square meters, a drop of 52.4% over the same period of 2007.

A 50+% decrease in sales leaves much new housing vacant. By the end of December, 2008, the number of salable houses and apartments under construction in Beijing reached 188,031, while finished but unsold houses and apartments totaled 174,290, leaving over 360,000 units on the market. If they are sold at 120,000 a year, the rate in 2007, it will take at least 3 years to sell them all, and that’s if no more are built....

The drop in new housing prices has also directly affected the prices of used housing. According to 21st-Century Real Estate, prices for 85% of the second-owner housing on the market saw an average price fall of 8.9% in the second half of 2008...

2009 will be a year of adjustment for the real estate industry....Any boom in a real sense, with rising housing prices, won’t come until 2011 at the soonest

Savills, one of the world’s largest property service firms, reckons the 2008 vacancy ratio of A-level commercial property in Shanghai’s Pudong district may be as high as 25.6%.

And then there is the residential market. In 2008 in Shanghai, new housing turnover slumped by 57%, year on year. In Nanjing and Hangzhou, the other two big cities in the Yangtze River Delta, trading volume slumped by 54.3% and about 50%, respectively. Prices in these three cities have not been cut, but industry insiders believe it is just a matter of time before developers will have to do so to promote sales, perhaps by as much as 15% to 20% in 2009

And the last sighting, from People's Daily, "69.6% of Beijing residents affected by financial crisis":

69.6% of the respondents said they were "directly affected" by the financial crisis, according to a specialized survey of over 2,000 respondents in 18 districts and counties in Beijing released by the Beijing Social Facts and Public Opinion Survey Center.

Those who believed that they were "severely" affected account for 15.7% of respondents. Of which, the percentage of respondents who chose this option was highest in the 41 to 50-year-old age group, reaching 22.2%.

Moreover, the survey shows that those who were least affected by the financial crisis were teachers, and those who were affected the most were "self-employed/freelance workers."...

Among households with incomes less than 10,000 yuan per month, the lower the income of the household the greater the impact they felt from the financial crisis.


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