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Yuan to the conclusion

Vyacheslav Kushnarev on how and why the Chinese government is struggling with the outflow of currency

Yuan to the conclusion

Vyacheslav Kushnaryov

Director of the Far Eastern Institute of Management RASHiGS
According to the most conservative estimates, hundreds of billions of dollars are withdrawn from China every year. Unfortunately, official statistics does not give exact figures, and cannot give them, since most of the operations are of quasi-legal nature. About the urgency of the problem of "capital flight" says active government policy on the regulation of foreign exchange and foreign trade operations. Despite this, the withdrawal of capital continues, and in fact it turns out that the cause is not only economic motives.

"Capital flight" is an impersonal term, since it does not refer to those who, in fact, derive this capital. The term also does not tell us anything about the specific causes of this process, it just states a certain symptom - something causes the holders of capital to withdraw money from the economy. And it is not at all easy to understand what exactly is the cause in each specific case, but, as a rule, the answer to this question is closely related to the one who owns this deducible capital.

Foreign investors and falling economic growth rates

The decline in economic growth is considered to be a deterioration in the economic situation. The most sensitive to such changes is considered to be foreign investors, since they have international experience and know how to transfer capital quickly and with less losses from a country with a deteriorating conjuncture to a country with a more stable one. It is this explanation of the "flight of capital" that we often hear in the media.

For example, the well-known economic publication Bloomberg recently brought this argument to China, which is not surprising, since the decline in the growth rate of China's economy is one of the central economic themes of recent years. This argument contains figures that seem to confirm this trend: fluctuations in the growth rate of the economy is significantly correlated with the volume of annual foreign investment.

At first glance it may seem that foreigners were withdrawing money from China in 1999, 2009, 2012 and after 2014. But it is precisely in this hasty conclusion that the main mistake consists. Let us explain this with a short example. Suppose last year I invested 10 million rubles in the economy of China. This year I have invested another 8 million. It turns out that this year my investments in China fell by 20%, although in the past and this year I did not withdraw a penny from China. You should also read the graph above. Positive values ​​mean that in a given year foreigners invested more in the economy than in the previous year. The negative ones show that the amount of investments of this year is less than the amount of investments of the previous year. In other words, foreigners annually bring more funds to the Chinese economy than they withdraw, and there is no “flight” of foreign capital.

This is completely consistent with economic logic. GDP growth in absolute terms remains very tangible, and by world standards this growth is still huge. China's contribution to global growth over the past few years is estimated at more than 25%. For the period from 2017 to 2019, the World Bank predicts that this figure will reach 35%. Conclusion one - China remains one of the fastest growing economies with a huge domestic market, and if some capital is fleeing the country, then it is clearly not foreign.

Chinese investors and economic growth rates

Having dealt with foreign investors, let's look at the internal ones and try to look at their potential motivation. The rapid economic growth of the last 30 years has created a whole class of people with considerable private capital. Following the logic already mentioned, Chinese investors could also be interested in increasing investments abroad (that is, in the withdrawal of capital) with the worsening of the domestic economic conjuncture. But when looking at the numbers (see chart 2), this logic is not confirmed. In some periods, the growth of Chinese investment in other countries coincided with GDP growth (for example, 1991 year), in other years (for example, 2007), the opposite picture was observed.

To this we should add a few more conceptual limitations. In addition to the barriers that the Chinese government is building in the way of exporting capital abroad, there are a number of other factors that create a specific character of Chinese investment. So, China is making many strategic investments. At the same time, these investments can be both economically and politically conditioned - from joining the capital of high-tech Western companies and supporting start-ups in the field of green energy to purchases of European football clubs. In addition, this kind of investment, strictly speaking, can not be considered a "capital flight", as they strategically serve the purposes of companies that are in Chinese jurisdiction.

Capital and the risk of its depreciation

Another frequently cited argument concerns the expected devaluation of the yuan. The transfer of capital into dollars should ensure the protection of capital against depreciation following the Chinese currency. It is quite possible that episodically the outflow of capital from the country follows this logic. No wonder the Chinese government has repeatedly imposed restrictions on currency exchange. In 2015, there was a provision prohibiting one household from purchasing more than $ 50 thousand without any special reason. Also, the active sale of gold reserves by the Chinese regulator speaks of the government’s concern about the value of the national currency. But empiricism shows that the risk of depreciation is still not the central cause. During the 2000-x, when the yuan appreciated against the dollar, the volume of exported capital, according to some scholars, still grew, although it was more than covered by foreign investment.

Structural Causes

The foregoing suggests that devaluation and FDI are conjuncture factors that only indirectly affect a trend that is eluding official statistics. The trend itself should have other structural causes.

In this regard, it was interesting to read a recent study of the Oxford Sinologist Frank Gunter. The main reason he considers a seemingly innocuous thing at first glance - a sharp increase in the well-being of the population. In his opinion, many wealthy people somehow plan the future life of their families abroad. This thesis is confirmed by recent polls. So, half of the Chinese millionaires plan their move abroad or, at least, consider such an opportunity. And there are a number of reasons for this - from better ecology to better education for children.

To test empirically this hypothesis is not so simple, but there are a number of indirect confirmations. For example, for the third consecutive year, the US has become the most popular target for Chinese wealthy migrants. The fact that wealthy people emigrate to the US (and bring their own capital with them) says statistics on the US visa program EB-5. This program allows you to issue a residence permit under a special procedure if the applicant invests in the US infrastructure for more than $ 500 thousand. According to the official report of the US migration department, 2016 applications for this program were approved in 364. Simple arithmetic gives us a figure of $ 182 million investment, and this is most likely a very modest estimate of real volumes. It should be added that every year more and more wealthy people send their children to study in American and European universities and schools, which eventually settle abroad and transfer the inheritance closer to their new home.

The problem of capital flight thus becomes a problem of emigration of a wealthy part of the population. Therefore, the reasons for the outflow of capital should be sought in the causes of emigration. A professor from Oxford makes a strong enough assumption here. In his opinion (in part this is confirmed by anti-corruption investigations), many wealthy people in China earned their capital not in the most legal way - many were in the public service or "friends" with high-ranking officials. For this reason, the desire to leave the country is connected not only with a desire to live in better conditions, but also with fear of punishment, unpredictability of the judicial system, and with the advent of Xi Jinping also an active anti-corruption campaign. Curiously, even before this campaign, in 2011, the Chinese Central Bank published eloquent statistics about runaway officials. Among them was about 18 thousand people, each of which took out an average of $ 7 million. Thus, one of the main structural drivers of capital withdrawal is the desire to secure the accumulated funds.

The channels of "capital flight" and the struggle against them

As early as the end of the 90, the Chinese government actually declared war on "fleeting" capital. In 1990, with the help of specific financial transactions, the lion's share of capital withdrawal operations was spent. In 1998, a number of new rules were introduced, thanks to which it was possible to reduce the capital outflow through this channel by $ 100 billion over the next five years. However, during the same period, through the falsification of procurement reports, $ 98 billion was more than expected. Restrictions imposed on certain channels of capital withdrawal cause activation of others. And this game of "cat and mouse" continues to this day.

At the same time, welfare growth has led to an increase in demand for ways to withdraw capital. The largest geographical centers through which wealthy Chinese try to raise funds are the former foreign colonies of Macau and Hong Kong. In the first of these, in recent years, the purchase of jewelry and "transactions" with local pawnshop holders (which in 2015 led to mass police raids on these establishments) was a particularly popular method of withdrawing funds.
Through Hong Kong funds are deducted through the purchase of local insurance policies. If the insurance is large enough (for example, real estate insurance), then it in fact turns into an investment product, which can later be used as collateral for certain schemes of buying property abroad. The reaction to this was the imposition of restrictions on the purchase of Hong Kong insurance policies by the Chinese payment system UnionPay.

Chinese companies have also been regulated. In addition to the strict requirements for the justification of investment abroad, there are a number of legislative innovations. If in 2000, the company's currency earnings were immediately converted into yuan by the companies themselves, which increased in value with growing Chinese exports, but today the situation has changed dramatically. Due to devaluation expectations, companies began to “delay” foreign currency on their accounts. In response, the government introduced special rules according to which equivalent amounts of foreign and domestic currencies should be in the accounts of some banks and companies.

Even large and influential Chinese companies (including the corporation of one of the richest people of China Wanda Group), apparently, at the insistence of the central authorities had to cancel major transactions for 2017 year, as they would create an unwanted devaluation pressure on the Chinese yuan. The head of the Chinese Central Bank recently called foreign investments of Chinese wealthy individuals "blind" and "hasty", probably hinting at their excessive desire to withdraw funds from the economy.

And probably, the most discussed for today the channel of withdrawal of funds have become crypto-currencies. In many ways, this is why the Chinese government is most active (and at the same time aggressively) behaving in this area. On the one hand, it is aware of the potential development of the underlying technology and does not want to completely limit the development of block projects. On the other hand, the uncontrollability of financial flows is a real nightmare for the Chinese government.

Despite China's economic success, large sums of money are annually withdrawn from the country. At the same time, recognition of this problem for the Chinese government is very painful, because in any case it means that the system built in the country and its institutions are failing. If the reason for the expected devaluation of the renminbi, then we must admit that the yuan can at some point be an unattractive currency. If wealthy people send their families and property abroad, this means that China does not have enough comfortable conditions for living in prosperity. If it is a matter of runaway officials or unclean businessmen, it means that the law enforcement system does not work properly. All this together explains the determination of the Chinese government in the fight against the withdrawal channels. However, these measures of struggle, like the very struggle against the "flight of capital," seem to be only a remedy against the symptom of a more serious institutional "illness" that motivates people to seek new ways to withdraw money from the economy.
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