Tuesday, April 26, 2016

IIF Ruins The Party, Predicts Another $420 Billion In Chinese Capital Outflows This Year

Tyler Durden's picture

In early 2016, the biggest global macroeconomic risk factor was the accelerating capital outflows out of China over fears of currency devaluation (or simply because the local population knows better than anyone just how dire to domestic situation is and is rushing to park its assets offshore) and with good reason: after the PBOC burned through $1 trillion in reserves to offset capital flight starting in the summer of 2014, even the IMF chimed in with a concerned report suggesting China may have at most another half a trillion "buffer" left before it runs into illiquid assets which would prove virtually impossible to liquidate easily in the open market.
It got so bad that in January and early February, US equity futures would surge or slump based on a Yuan fixing that was a few basis point lower or higher than expected.
But then, almost as if on cue, following three consecutive months of nearly $100 billion in outflows, in February the capital flight slowed sharply and then proceeded to reverse (not if one includes FX adjustments but these days who actually does math) in March, leading to the first Chinese reserve increase since October. (assuming of course one believes Chinese data; one reason why one should not is everything that is currently going on in Vancouver real estate which proves the capital outflow has never been stronger).

So perhaps as a result of the rapid reversal in reserve liquidation or the stabilization in the offshore Yuan rate (where the PBOC has been particularly active in punishing shorts), fears about Chinese capital flights have been relegated to the back pages. Which is paradoxical, because not only have none of China's underlying problems been addressed, the only way China managed to sweep its all too glaring problems under the rug was with the aid of $1 trillion in new Q1 loans.
Of course, it was concerns about soaring bad debt (as well as a hard landing economy and plunging exports, but those are all derivatives of China's 350% in debt/GDP) that got China where it was in the summer and winter of 2015 in the first place, when it first started devaluing its currency. So to suggest that by adding even more debt on top of what was a debt problem somehow fixed it, well, debt problem is something only a full Krugman could suggest.
Which is why we were not surprised to read that according to the latest Institute of International Finance forecast, and in validation of Kyle Bass' strong conviction that China is about to suffer a major 15%+ devaluation, China's capital outflow headaches may be only just starting. According to the IIF's latest report released today, global investors are expected to pull $538 billion out of China's slowing economy in 2016, which means another $420 billion after the $118 billion that has already been withdrawn in Q1.

That number would be down a fifth from the $674 billion pulled out last year, the industry association said, but could be a stark acceleration from $118 in reserves sold in the first three months of the year as fears re-emerge of a "disorderly" drop in the yuan, or the renminbi, as the currency is also known.
"A sharp drop in the renminbi would likely spark a renewed sell-off of global risk assets and trigger a flight of portfolio capital from emerging markets," the IIF said in a new report.

"Moreover, a sharp depreciation of the renminbi could lead to a round of competitive devaluation in other emerging markets, particularly in those with close trade linkages to China."
As noted above, for now, however, outflows are slowing. Roughly $35 billion was pulled out in March, bringing the total since the start of the year to around $175 billion, well below the pace seen in the second half 2016.
The IIF cited progress Chinese authorities had made in easing worries about the yuan's direction. Once again, we fail to see what those are aside from one more trillion in loans and another unprecedented round of fiscal stimulus.
Ironically, the IIF forecast that:
  • We project net capital outflows to slow to $538 billion in 2016 from $674 billion last year, supported by a gradual recovery in non-resident capital inflows. However, there remain risks that outflows could accelerate again if concerns about RMB depreciation intensify again
Which is certainly not improvement but actually a sharp deterioration to the latest runrate inflow, considering it took the Shanghai Accord and countless central bank interventions to stabilize the Yuan, and the halt the Chinese outflows. The IIF's forecast is implicitly suggesting that what has been achieved is nothing but a pyrrhic victory and over the next three quarters, China is about to see another $420 billion in outflows, a dramatic deterioration to the status quo, one which would return the market into a full blown sell-off mode as that encountered at the end of 2015 and first two months of 2016 when panic over China's soaring outflows was all the rage.
So did the IIF just tacitly open the next Pandora's box in China's capital flight tale? In its own conclusion, the IIF hopes for the best:
In our baseline projections, capital outflows and pressure on the RMB persist through 2016, but diminish in intensity as policymakers persuade investors that they will be successful in stabilizing the RMB’s value.
With brute central bank intervention to punish anyone found shorting the CNH. Anyway, continuing:
Greater confidence that the economy is on track to meet the growth target of 6.5-7 percent would also help. Most of the improvement is projected to
be in a turnaround in non-resident capital flows, while resident outflows and errors and omissions are forecast to moderate more gradually
That confidence won't come to anyone who does an even cursory look behind the scenes because as we have reported over the past week, none of the Chinese numbers - be they imports, annualized GDP or province level GDP - actually make any sense.
The IIF conludes as follows:
Nonetheless, China remains vulnerable to a renewed intensification of capital outflows, particularly if doubts about the stability of the RMB were to come to the fore again. In particular, stress could rise through a combination of a stronger USD—particularly if the market comes to believe that the Fed will tighten more quickly than currently priced in—and further disappointment about China’s growth momentum.
So yes, any Fed rate hikes and we are right back out of the eye of the hurrican, but even more amusing would be if we end up in the same spot if after reading this report the market realizes that after managing to restore inflows, China is now expected to see another $400 billion in outflows for the rest of 2016 as per the IIF's "benign" forecast, and proceeds to panic all over again.


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