China’s official narrative holds that investors can expect a steady and orderly opening up of its capital account, which will enable them to make inbound as well as outbound investments. However, recent data suggests that, if anything, the country’s capital controls are becoming stricter.
One interesting litmus of China’s unofficial outbound flows, is tourism.
With citizens permitted to exchange just $50,000 of foreign currency a year – any amount exceeding this requires a permit from China’s State Administration of Foreign Exchange (SAFE) – a foreign jaunt has always been a favoured conduit for backdoor capital flight.
Traditionally, tourism has stood next to over-invoicing of imports and under-invoicing of exports (as well as buying trophy assets overseas with no clearcut valuations), as the main method of disguise for outbound investment.
Tougher treatment
However, a report released by Natixis last month suggests that while China may have opened up its borders to outbound tourism this year, its capital account remains as rigorously scrutinised as ever, and possibly, even more so.
Natixis embarked on calculating its data by collecting all available tourism receipts and expenditures from China’s official balance of payments data. Next, it identified the key markets missing from the China datasets and estimated potential capital flows based on their market share of Chinese tourists.
In short, the research found the difference between estimated and actual expenditure by Chinese tourists in a particular host country to suggest net capital outflows through tourism but for other purposes.
For Chinese authorities, the problem is sizeable and very real.
In 2015, the gap between China’s disclosure of international trade via commercial services or travel and global disclosure, came to $93.3 billion. This gap rose to $98.6 billion, in 2016.
While the figure for 2020 scales back to $68 billion (just 0.5% of China’s GDP), Covid-19 restrictions only go part of the way to explaining the reduction.
Constant pressure
According to Natixis Chief Economist for Asia Pacific, Alicia Garcia-Herrero, the pressure from Chinese residents to diversify their assets is constant, but their ability to disguise what really amounts to capital outflows, is becoming more difficult.
“For us at Natixis, the current numbers seem small as they were almost 30% bigger in the past, the question is why?” Garcia-Herrero told FinanceAsia.
“The pandemic, we believe, is not enough to explain the reduction in this gap.”
She explained that the shrinking value of this unrecorded capital flow, which first revealed a dip in 2017, is likely to be part of a bigger trend, rather than a reflection of travel anomalies during the pandemic.
“Is it harder for Chinese citizens to bring their money out of the country? In our opinion, probably so,” she said.
However, she noted that the Natixis study did not want to overstate the importance of tourism in disguised capital flight. Other methods, such as over- and under-invoicing, as well as the purchase of trophy companies and assets remain other key avenues that investors use to escape detection, she explained.
“For instance, a large asset such as a hotel in the UK might be given a valuation of £100 million ($121.66 million), but is actually only really worth £20 million,” she said.
“Of course, Chinese travellers can’t travel with that kind of money and are unlikely to buy a hotel. But the point we’re making with this study, is that this channel is more socially accessible and while less obvious, it gives an indication of the outline of capital controls in China.”
Schemes fall short
According to Natixis economist Gary Ng, who also worked on the report, China’s efforts to release some of this pressure through various internal investment schemes can only cater for a fraction of the demand.
“It seems there are a lot of mechanisms now being set up to screen these outbound money flows,” he told FA.
“The authorities do try to cater to this demand for diversification through trading platforms such as Stock Connect, but it’s still a closed loop system. If you buy an asset in Hong Kong, for example, it will still go back to the mainland.”
Garcia-Herrero added that while it remains difficult to pinpoint exactly where and how such restrictions are being imposed, there is other evidence to suggest controls are tighter than ever.
The quotas in mechanisms such as the qualified domestic institutional investor (QDII) – a scheme that allows institutional investors that meet certain qualification criteria to invest in securities in foreign markets – remain full.
“These quotas have never been lifted and have been completely full ever since I can remember,” she said.
“If you argue that China is indeed opening up its capital account – a narrative that the authorities are pushing – then this is certainly not true for QDII.”
Indirect controls, too, such as restricting the ability to easily access passports has been another way to limit unrecorded outflows.
“We’ve seen this with the return of travel from the mainland. The numbers to Hong Kong have increased, but they haven’t ballooned as expected. Travelling is just not easy,” she said.
Restrictions to remain
Professor Zhiwu Chen, who holds the Chair of Finance at Hong Kong University (HKU), said that no one should hold their breath waiting for China to liberalise its capital account.
“The main thing is that, when the Chinese authorities talk about capital account liberalisation what they’re actually talking about is inbound capital controls,” he said.
“They would love to have foreign capital flowing into China, so it’s effectively a one-way loosening.”
He told FA that these restrictions are likely to stay in place for the foreseeable future.
“As geopolitical tensions get worse, the demand for moving capital out of China will only get higher,” Professor Chen said.
“What will the government do in response? Well, they are not going to make it easier for people to move capital out, instead they will only make it harder. But, at the same time, they will welcome foreign investment into China.”
“This direction will continue maybe for the next two decades – if not, even longer.”
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