China’s two-way liquidity risk: capital outflows

FT ^ | 08/01/12 | Kate Mackenzie

[TigerLikesRooster]

China’s two-way liquidity risk: capital outflows

Posted by Kate Mackenzie on Aug 01 12:11.

Izzy wrote in May how China’s Rmb exodus is a huge (and still little-explored) story for the world economy, and it’s one that won’t be going away as China recorded a net capital account deficit in Q2. We’re wondering now how this might collide with risks to domestic liquidity — specifically, whether a combination of Rmb exodus and local banking problems might affect the People’s Bank of China’s ability to maintain financial stability?

A very brief recap on the Chinese foreign reserves-domestic liquidity nexus:

- Demand from US dollar holders (domestic or foreign) to convert their holdings to yuan has typically been strong, because China’s currency peg means the PBoC pays a favourable rate. - This creates a lot of Rmb inside China’s economy, which is sterilised by raising China’s required reserve ratios (RRR). - However, that demand has been falling of late as preferences switch from Rmb to USD. - We’ve already seen the PBoC respond to liquidity shortfalls by reversing its normal ‘repo’ operations.

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P!

[1010RD]

The Chinese economy is very weak. There are hundreds of unfinished major construction projects. The misallocation of resources driven by political rather than economic reasons is the source of the problem. Of course, not just in China, but anywhere it is tried.