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Capital flowing out of China at more moderate pace
A year after global markets were shaken by a surprise China devaluation, they are now becalmed, and pressures for an exodus of capital from the nation have eased.
 
Diminished expectations for US interest-rate increases have helped stem the tide. Authorities also have cracked down on savers squireling money out through everything from dubious invoicing to purchases of overseas insurance products.
On the economic front, stability reigns for now. The nation's foreign exchange reserves have levelled out at about $US3.2 trillion ($4.2 trillion), and data Tuesday showed a streak of factory-gate deflation may be coming to an end after more than four years. Other indicators suggest overall economic growth is holding up and the People's Bank of China has signalled it isn't in a hurry to cut interest rates, even as it adds stimulus through other channels.
 
Authorities soothed concerns by promising not to devalue the yuan in order to help exporters. Even as the yuan has weakened about 2.4 per cent against the US dollar this year, markets have grown comfortable with the country's new trading mechanism – taking panic out of the equation.
 
Having said all of that, cash is still leaking out of the world's No. 2 economy. That means worries won't go away that a sudden yuan weakness could trigger another burst of destabilising capital outflows.
 
"All it takes is one snowballing rumour of policy change or further renminbi devaluation to trigger the next rush for the doors," said Pauline Loong, managing director at Asia-Analytica Research in Hong Kong. "The domestic mood is one of worry and uncertainty."
 
Case in point: when the yuan fell about 1 per cent against the US dollar and 2.2 per cent versus a trade-weighted index in June, some $US49 billion worth of foreign exchange flowed out, up from $US25 billion in May, according to Goldman Sachs Group.
 
Analysis by Nomura Holdings of Chinese imports in the six months through June found that capital outflows may have been disguised as imports from tax-haven and offshore financial centres. Shipments from Samoa soared 723 per cent over the period and those from the Bahamas rose 354 per cent, according to the Nomura analysts led by Yang Zhao. At the same time, overall imports fell.
 
Equities appeal
 
The weakening yuan also prompted China's investors to pile into equities in Hong Kong, where the currency is pegged to the greenback. Mainland traders have bought a net 93.1 billion yuan ($18 billion) of shares listed on the city's stock exchange this year, according to data compiled by Bloomberg tracking investments via the exchange link with Shanghai. By contrast, net inflows into mainland equities via the two-way channel have amounted to 26.6 billion yuan in the period.
 
Much of the money that has left China is still unrelated to capital flight. Companies have paid down foreign debt and have pursued legitimate investments. The outflows also reflect asset diversification and parents paying for their children's education abroad.
 
Indeed, even as money heads out through some channels, it's coming in via others. Foreigners' holdings of Chinese stocks climbed to the highest in a year in June. Bond inflows that month also rose the most since 2014 as the government increased overseas access to the market and the nation's relatively high yields lured investors.
 
China also has a healthy trade and current account surplus to act as a buffer, said David Loevinger, a former China specialist at the US Treasury who is now an analyst at fund manager TCW Group in Los Angeles.
 
"So even if it has net capital outflows, as long as they're not too big or too sudden, then I think China and the PBOC can manage it," Loevinger said.
 
Still, the ballgame may change should the US Federal Reserve resume raising interest rates more aggressively than currently forecast, strengthening the greenback and weakening the yuan. Then there's the risk of policy error.
 
"If something shocking happens like last August or early this year, when everybody was worried about the systemic risk of China, then this process will definitely accelerate, leading to panic capital flight," said Harrison Hu, chief greater China economist at Royal Bank of Scotland, referring to the process of asset diversification.
A year after global markets were shaken by a surprise China devaluation, they are now becalmed, and pressures for an exodus of capital from the nation have eased.
 
Diminished expectations for US interest-rate increases have helped stem the tide. Authorities also have cracked down on savers squireling money out through everything from dubious invoicing to purchases of overseas insurance products.
On the economic front, stability reigns for now. The nation's foreign exchange reserves have levelled out at about $US3.2 trillion ($4.2 trillion), and data Tuesday showed a streak of factory-gate deflation may be coming to an end after more than four years. Other indicators suggest overall economic growth is holding up and the People's Bank of China has signalled it isn't in a hurry to cut interest rates, even as it adds stimulus through other channels.
 
Authorities soothed concerns by promising not to devalue the yuan in order to help exporters. Even as the yuan has weakened about 2.4 per cent against the US dollar this year, markets have grown comfortable with the country's new trading mechanism – taking panic out of the equation.
 
Having said all of that, cash is still leaking out of the world's No. 2 economy. That means worries won't go away that a sudden yuan weakness could trigger another burst of destabilising capital outflows.
 
"All it takes is one snowballing rumour of policy change or further renminbi devaluation to trigger the next rush for the doors," said Pauline Loong, managing director at Asia-Analytica Research in Hong Kong. "The domestic mood is one of worry and uncertainty."
 
Case in point: when the yuan fell about 1 per cent against the US dollar and 2.2 per cent versus a trade-weighted index in June, some $US49 billion worth of foreign exchange flowed out, up from $US25 billion in May, according to Goldman Sachs Group.
 
Analysis by Nomura Holdings of Chinese imports in the six months through June found that capital outflows may have been disguised as imports from tax-haven and offshore financial centres. Shipments from Samoa soared 723 per cent over the period and those from the Bahamas rose 354 per cent, according to the Nomura analysts led by Yang Zhao. At the same time, overall imports fell.
 
Equities appeal
 
The weakening yuan also prompted China's investors to pile into equities in Hong Kong, where the currency is pegged to the greenback. Mainland traders have bought a net 93.1 billion yuan ($18 billion) of shares listed on the city's stock exchange this year, according to data compiled by Bloomberg tracking investments via the exchange link with Shanghai. By contrast, net inflows into mainland equities via the two-way channel have amounted to 26.6 billion yuan in the period.
 
Much of the money that has left China is still unrelated to capital flight. Companies have paid down foreign debt and have pursued legitimate investments. The outflows also reflect asset diversification and parents paying for their children's education abroad.
 
Indeed, even as money heads out through some channels, it's coming in via others. Foreigners' holdings of Chinese stocks climbed to the highest in a year in June. Bond inflows that month also rose the most since 2014 as the government increased overseas access to the market and the nation's relatively high yields lured investors.
 
China also has a healthy trade and current account surplus to act as a buffer, said David Loevinger, a former China specialist at the US Treasury who is now an analyst at fund manager TCW Group in Los Angeles.
 
"So even if it has net capital outflows, as long as they're not too big or too sudden, then I think China and the PBOC can manage it," Loevinger said.
 
Still, the ballgame may change should the US Federal Reserve resume raising interest rates more aggressively than currently forecast, strengthening the greenback and weakening the yuan. Then there's the risk of policy error.
 
"If something shocking happens like last August or early this year, when everybody was worried about the systemic risk of China, then this process will definitely accelerate, leading to panic capital flight," said Harrison Hu, chief greater China economist at Royal Bank of Scotland, referring to the process of asset diversification.
 
Banks face growing political heat over their rate decision, with Prime Minister Malcolm Turnbull on Wednesday demanding the lenders explain why borrowers will not get the RBA's 0.25 percentage point reduction.Australia's major banks stand to hang on to $917 million in combined profit by only giving mortgage customers roughly half the Reserve Bank interest rate cut, according to analyst estimates.
In a move to limit a squeeze on their profit margins, Commonwealth Bank, Westpac, ANZ Bank and National Australia Bank are lowering mortgage rates by between 0.1 and 0.14 percentage points, compared with the Reserve Bank's 0.25 percentage point cut on Tuesday.
 
Late on Wednesday Suncorp said it would also cut mortgage interest rates by 0.1 percentage points.
Although the banks are also raising some term deposit rates, which will lift their funding costs over time, the small rate cut on its own is expected to benefit the big four's yearly profits by between 2 and 3 per cent.
 
ANZ's after-tax profit would benefit by $165 million, Commonwealth Bank's by $262 million, National Australia Bank's by $226 million, and Westpac's bottom line would gain $264 million, Macquarie analyst Victor German estimated。
The combined benefit across the big four, which blamed the small rate cut on higher funding costs, is $917 million, according to Mr German's figures.
 
Over the longer term, however, other forces unleashed by interest rates falling to new record lows are negative for banks, and the market's reaction to Tuesday's cut has been to sell off bank shares.
 
Shares in each of the big four were down sharply on Wednesday afternoon, with CBA dropping 1.7 per cent, ANZ down 2 per cent, NAB losing 2.4 per cent and Westpac falling 2.3 per cent.
 
Investors are weighing up the benefit of the partial pass-through of the RBA's interest rate cut against the longer-term squeeze on bank's net interest margins - the difference between what they pay for funds and the cost of loans.
 
Competition for new customers
 
Even though Tuesday's move by banks helps preserve returns from existing loans, there is intense competition for new customers. That means new loans are being written at lower interest rates.
 
Banks this week also raised some deposit interest rates, mainly for term deposits with a term of one-year or longer, which raises their costs.
 
Mr German said there were other factors dragging on bank profits, but the impact of only passing on some of the RBA's cut appeared positive.
 
"It's difficult to see how earnings do not get an uplift on the back of what they've done."
 
Banks have increased interest rates on longer-term deposits, but Mr German pointed out this impact would be more gradual because it only apply to new deposits, not existing deposits. He also said three- to four-month deposits tended to be the most popular with customers.
 
"The question is to what extent you will get new customers moving their deposits from more popular short -term products to nine months plus to get the attractive rates. It's really the growth of that product that will determine what it will ultimately cost banks," Mr German said.
 
Morgan Stanley analyst Richard Wiles said in a note that banks' net interest margins would drift lower, even with the favourable mortgage rate changes, and he thought there was "downside risk" to bank earnings from fierce competition between them to attract deposits.
 
CLSA analyst Brian Johnson predicted banks would need to continue competing more aggressively to win deposits, in preparation for 2018 rules on how banks are funded, and this would dampen profitability.
 
"It feels to me as though this is net negative on their profits," Mr Johnson said.
 
It is not the first time banks have raised some term deposits at the same time they have made unpopular mortgage decisions.
 
Several banks also raised term deposit rates in May last year, when they withheld part of the RBA's cut, but within a few months they had reversed their deposit rate decision.
 
Banks face growing political heat over their rate decision, with Prime Minister Malcolm Turnbull on Wednesday demanding the lenders explain why borrowers will not get the RBA's 0.25 percentage point reduction.
 
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