A pivotal theme for 2017 will be capital outflows from China leading to contraction of domestic liquidity. Policymakers in China managed boost domestic liquidity earlier this year by state-directed lending, but there are signs capital is leaking out at an accelerating rate. The chart below shows FX reserves are falling at a greater rate.  Even if we take account of valuation effects due to the rising dollar and falling USTs we can see that the PBoC has generally had to intervene more to prevent too great a depreciation in the yuan.

img1Source: Bloomberg and Variant Perception

Authorities in China are tightening their grip to prevent capital leakage.  This is especially important in a country where much of the wealth is concentrated in few hands – it only takes a very small minority of people/corporates to act to have a large impact on capital outflows.  Recently the government announced that all capital transfers abroad of over $5 million would need to be approved by the State Administration of Foreign Exchange.  Today, they announced they will increase scrutiny of FX purchases by citizens.

China pulled off a great feat earlier this year by mandating an increase in credit to stabilize growth and capital outflows.  However, considering the next chart, it is not clear how long China can continue allowing credit to deviate so far from trend without a pullback at some point.

img2Source: Bloomberg and Variant Perception