In this note, we analyze the latest trend of China capital outflows using the newly released 2016 balance of payments (BoP) data, as well as the monthly indicators year-to-date.

In 2016, total capital outflows edged down to US$640bn from US$ 647bn in 2015. The underlying drivers shifted to direct outward investment and acquisition of foreign assets by Chinese residents in 2016, from withdrawal of onshore deposits by foreigners and FX loan repayment in 2015. After including net errors and omissions (NEO) in the BoP data as (hidden) outflows, total capital outflows appeared to have peaked in 2015 and edged down in 2016. Meanwhile, quarterly capital outflows started to slow in 4Q16, as direct investment swung from outflow to inflow . More specifically :

Outflows via direct investment increased notably by US$114.7bn YoY in 2016. Direct investment recorded US$46.6bn net outflows in 2016, compared with US$68.1bn of net inflows in 2015. More specifically, gross outward direct investment increased US$42.8bn in 2016 compared with 2015, while gross FDI inflows declined US$71.9bn.

Capital outflow via “other investment” items declined visibly to US$303.5bn from US$434bn in 2015. Foreigners’ deposits in RMB increased US$10.2bn in 2016, compared with a net withdrawal of US$122.6bn in 2015. Meanwhile, repayment of FX loans, which is recorded as “outflow”, has slowed notably in 2016 to US$19.6bn from US$166.7bn in 2015 – it is worth noting that China’s external debt in foreign currencies has increased US$173.8bn since 2Q16. Furthermore, net outflows under trade credit and advances declined to US$84.6bn in 2016 from US$108.2bn in 2015, indicating less “hoarding” of FX proceeds by exporters. In 2016, Chinese residents acquired more foreign assets in the form of loans and other assets, contributing to a total increase of US$210.8bn in capital outflows – new lending to foreigners increased US$67.3bn to US$114.7bn in 2016, while Chinese residents’ holding of other foreign assets increased US$74.3bn in 2016, compared with a decline of US$69.2bn in 2015.

Portfolio investment outflows stayed relatively stable. Outflows under the portfolio investment declined US$4.3bn to US$62.2bn in 2016 – foreign portfolio investment in domestic securities (mostly bonds) increased US$34.5bn in 2016, while Chinese residents allocated an additional US$30.2bn into foreign securities.

Hidden capital outflows remained elevated in 2016, indicated by total NEO of US$222.7bn, slightly higher than US$213.0bn in 2015.

High-frequency indicators suggest that capital outflows may have slowed more visibly in 1Q17, potentially driven by a further increase of FX loans, fewer direct investment outflows and exporters’ repatriation of FX proceeds. We estimate that capital outflow in 1Q17 may have fallen to < US$50bn, compared with US$154bn in 4Q16. Our estimate is based on the changes in FX reserves, estimated valuation effect based on our calculation of currency weights , and SAFE trade data of goods & services . More specifically, external debt continued to grow in 2017, while the gap between trade-related FX settlements and the trade surplus has narrowed meaningfully year to date. In addition, we have seen net FDI turning positive since 4Q16 after the stricter guidelines were issued over foreign acquisitions and direct investments .

Looking forward, capital outflows are likely to ease notably in 2017 as RMB depreciation expectation recedes further. Consequently, we may see potential loosening/removal of capital controls since 4Q16 that are more ad-hoc in nature. Granted, the moderation of capital outflows since 4Q16 was partially driven by the tightening of capital controls, especially measures to slow domestic FX purchase, as well as foreign direct and portfolio investments. Meanwhile, exporters’ repatriation of FX proceeds may have also speeded up amidst tighter regulations. However, administrative measures aside, a few indicators point to easing RMB depreciation expectation in recent months driven by the economic recovery, including rising domestic and external FX loans. We expect the RMB depreciation expectation to ease further in 2017, on the back of continued recovery of domestic investment returns and a relatively stable USD. Therefore, the possibility has risen for the more ad-hoc capital control measures to be loosened/removed in the near future.