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China’s cat-and-mouse game over capital outflows set to continue

At the end of last week, Beijing fired off more detailed instructions on sectors where direct overseas investment is prohibited, restricted or encouraged respectively, leaving no doubt that the government is determined that there will be no going back to the events of 2015 and 2016. At that time, the renminbi weakened sharply, capital outflows surged and the stock market crashed.

In Beijing’s view, financial risk remains paramount still — even though the scary, unvirtuous circle of a weakening renminbi, ever increasing capital outflows and deficits on both the capital and financial accounts of two years ago has been reversed.

Stability on the financial front in China removes one of the biggest global fears that obsessed investors some months ago. Not all of the improvement is due to Beijing of course — but some is. Still, investors have to wonder whether, even as Beijing reduces financial risks, the political risk that led to huge capital flight continues to lurk beneath the surface.

Today, the underlying fundamentals of the Chinese economy have improved markedly. Capital outflows have dropped significantly. The deficit on the capital and financial accounts has shrunk from $640bn for all of last year to a mere $42bn in the first half of this year. Moreover, in accordance with Beijing’s wishes, in the first half of 2017, overseas direct investment contracted by about two-thirds (accounting for one-third of the narrowing of China’s capital outflows during the period, according to data from JPMorgan). And if the economy slows a bit in the second half of the year as controls cool the property market — well, that also is a good thing since China has become too dependent on real estate for growth.

“We expect the tighter capital scrutiny will keep the outflows subdued, and that the property sector ODI [overseas direct investment] will be the most affected,” notes Robin Xing, China economist at Morgan Stanley, who believes that the renminbi will end 2017 at about 6.6 to the dollar, a far cry from the 7 to 8 that some bearish analysts were anticipating not long ago.

To be sure, a new study from JPMorgan shows that the fears about the capital outflows were only partly due to the heavier hand from Beijing directed at its wayward private enterprises. At the same time, “the corporate sector’s adjustment of its FX assets and liabilities has been an important driver of swings in China’s capital flows,” note JPMorgan economists led by Haibin Zhu. “Corporates’ reduction of their foreign debts accounted for 40 per cent to 50 per cent of total capital outflow between Q4 2014 and Q1 2016 but appear to have reversed since early last year.”

Both capital outflows and Beijing’s efforts to reverse them are ultimately about politics as well as finance and are closely tied to the anti-corruption campaign. Those who have the approval of Beijing are allowed to do what those who are out of favour cannot; banks finance those who are not only creditworthy but politically correct. Today, the four big serial acquirers of offshore assets, Anbang, Dalian Wanda, Fosun and HNA, have been restrained but it still isn’t clear whether all big deals will be suppressed, or others will be allowed to fill the vacuum going forward.

The prospect of less money from Chinese buyers will have an impact on everything from cash-strapped financial institutions and sports teams in Europe to the owners of Hollywood studios and luxury properties in New York and Singapore. Wanda this week scrapped a plan to spend £470m on a plot in London.

Meanwhile, speculation about the next big transaction has been replaced by speculation about what is euphemistically referred to as “asset reallocation” or what will happen to existing offshore holdings of these four groups. Will they be allowed to keep the companies and assets they control or will their holdings be “reassigned” to others? And if so, who might those others be? The answers to such questions are far from clear.

In any case, some investors believe that once the 19th Party Congress, (now scheduled for October), winds down, Beijing’s economic restrictions will ease.

Still, it is hard to believe that even after October the cat-and-mouse game will cease. Both ordinary households and the richest billionaires will continue their attempts to put their money abroad. Indeed, “a meaningful portion of Chinese tourist spending overseas may reflect disguised capital outflows from households,” Mr Zhu adds.

But even as investors can breathe easier about economic prospects, the political calculations will be both more critical and more complicated.

henny.sender@ft.com