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01 11 2017 | by Victor Xing | Economics

Financial risk contagion: China’s capital outflow

China’s capital outflow as a potential financial risk contagion

PBOC’s new policies to combat capital outflow is creating a new risk contagion.  Even though Chinese citizens’ $50,000 annual forex quota is to remain unchanged, the following rules were added to restrict the use of these purchases:

  • The FX quota can no longer be used to buy properties, investment securities, life insurance or other dividend paying insurance products
  • Violators will be added to SAFE’s watch list, denied of annual FX quota for three years, and subject to anti-money-laundering investigation (felony offense)
  • Purchases of foreign currencies by individuals can be used only for personal or business travels abroad, overseas study, family visits or medical treatment, merchandise trade and purchases of non-investing insurance policies

Market participants in the real estate sector are well aware of Chinese buyers’ outsized impact, which was quantified in a 2016 National Association of Realtors report:

  • Chinese buyers accounted for 26.7% ($27.3 billion) of all international sales in 2016
  • Foreign buyers as a cohort paid an average of $477.5K for a house, compared to $266.7K in aggregate data
  • All-cash purchases accounted for 50% of the purchases, with 41% of the buyers relied on U.S.-based mortgages
  • Primary residence and housing for students accounted for 53% of Chinese purchases (18% investment)

Capital Outflow

First-order impact of more restrictive dollar-inflow into the U.S. will be seen in home sales and home prices data, although second-order effect would weigh on multifamily REITS as a sizable cohort of “involuntary renters” re-enter into the housing market as potential buyers (albeit without the balance sheet strength of Chinese buyers).

Some market participants have argued that housing’s contribution to real GDP is but a shadow of its former self (2.6% in 2015 vs. 3.3% in 2005), but a substantial decline will still weigh on Federal Reserve’s policy reaction function (especially given still-fresh memory of the housing downturn).  The post-crisis housing recovery also boosted job growth in construction-related sectors.  Between December 2010 and December 2016, a total of 1.1 million new jobs were created thanks to the housing recovery (either directly, such as construction, or indirectly via additional “specialty trade contractors”), and price-insensitive Chinese buyers played a notable role.

Capital Outflow

Nevertheless, these impacts will likely take time to manifest due to the length of pipeline between offshore yuan deposits and onshore dollar funds.  Sources at commercial banks indicate that funds that were already moved on-shore in prior months are still being put to work.

Thus, data in the upcoming months will be crucial to establish the magnitude of this demand disruption, as realized impact on the housing market is also subject to the efficacy of PBOC’s policy (and the existence of underground outflow channels).  Taken as a whole, this catalyst has the potential to dampen record-level risk sentiment and alter the course of Federal Reserve monetary policy.

Next article12 22 2016 | by Victor Xing | Economics

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