China: What happens when the free greenbacks dry up?

Alicia García-Herrero

Chief Economist Emerging Markets

BBVA Research

Foreign Correspondents’ Club of China, Beijing

May 2014

China: What happens when the free greenbacks dry up?


Outline

Section 1

Global economic outlook Section 2

The FED exit

Section 3

Impact on Emerging Markets: What is it for China Section 4

Conclusions for China

Page 2


Global Economic Outlook

1

2

Global expansion moderating with China growing less than previously expected and without immediate risks of a sudden adjustment

The combination of the Fed tightening and (further) adjustments of China’s growth will be the dominant factors in the coming months (absent an ECB’s QE) with an heterogeneous impact on EM

Global GDP growth (%) Source: BBVA Research

Page 3

2.8

-0.4

5.2

4.0

3.23.0 3.4

3.8

-2

-1

0

1

2

3

4

5

6

2008 2009 2010 2011 2012 2013(e)

2014(f)

2015(f)

Developed Mkts Emerging Mkts

Baseline Jan14


0

50

100

150

200

250

300

350

400

450

500

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Tape

ring

QE3

+Dra

gui

Forecasts

Monetary Policy & Capital Flows

5

6

In any case, EM Portfolio Capital Flows are still below equilibrium and should start to navigate to their long run trend

After being particularly penalized by the US tapering Emerging Asia will follow this path too

Page 4

Emerging Asia: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

Actual: -17% (undershooting)


The government will press ahead with reforms and implement measures to curtail

financial risks

China: Updating our baseline scenario due to poor incoming data and new assumptions on economic policy

Page 5

We expect a higher adjustment in investment than in consumption

Policy supports from public expenditure (infrastructure investment, tax reliefs) would be implemented if domestic economy loses momentum below the bottom line of 7.0%

China: GDP Growth (%, y-o-y) Source: BBVA Research

7.7 7.7

7.27.0

5.0

5.5

6.0

6.5

7.0

7.5

8.0

2012 2013 2014 2015

Baseline Apr-2014 Baseline Jan-2014


Outline

Section 1

Global economic outlook

Section 2

The FED exit Section 3

Impact on Emerging Markets: What is it for China Section 4


Page 6


US: GDP Forecast, QoQ SAAR % change Source: BBVA Research

Source: BBVA Research

-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5

The US Tapering is already here and signs of economic improvement are materializing…

The rebound after the winter months is more evident, particularly in consumption.

Job growth is not expected to accelerate significantly in 2014 and inflation is expected

to increase slowly.

However, weaker global demand and some housing sector pressures are limiting the pace

of expansion.

We maintain our baseline scenario mostly unchanged (2.5% GDP growth for 2014 and 2015), slightly elevated upside risk to GDP

growth

Page 7


US monetary policy: Fed funds scenario unchanged, risk tilted towards an earlier rate hike

Mid – 2015

Maintaining the 3Q15 baseline but

with lower likelihood as the

probability of early rate hike increased

FOMC Statement: April 29-30, 2014

Monthly pace of asset purchases tapered to $45bn – spread to $20bn in MBS and $25bn of Treasury securities

Forward guidance left untouched bringing back unanimous FOMC vote

Changes to FOMC voting members by June 17-18 meeting.

Two incoming Governors, vice-chair Fischer and Brainard, will likely be in place to vote, one Governor, Stein, leaving

Centrist voter, Pianalto, Cleveland FRB, will be succeeded, by likely hawkish Mester

Fed

Measured steps of $10bn reduction of QE3

Course of policy firming remains data dependent

Anticipated changes to June projections on “pace of policy firming” due to new, incoming FOMC members

FOMC likely to introduce further modifications to the forward guidance throughout the policy normalization process

Latest What do we expect? Policy pause until

4Q14

Expected End QE3

3Q15

First FFR Hike

1H16

Policy Normalization Balance sheet: let securities

mature/sales

Expected Timeline

for Exit

Strategy Page 8


Outline

Section 1


Section 2

The FED exit

Section 3

Impact on Emerging Markets compared with China Section 4


Page 9


Page 10

Net Portfolio Inflows : Developed vs Emerging (Country Flows over Total Assets, moving average 3 months) Source: EPFR and BBVA Research

Net Portfolio Inflows : Regional Emerging Mkts (Country Flows over Total Assets, moving average 3 months) Source: EPFR and BBVA Research

QE tapering at first dramatic for EMs but improving


Emerging Markets: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

Path of recovery strong but should moderate


-200

-100

0

100

200

300

400

500

600

700

800

900

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Tape

ring

QE3

+Dra

gui

Eq. reached by Dec 2014 (model forecasted pace)

Emerging Asia*: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

(*) Includes: China, India, Indonesia, Philippines, Thailand, Korea, Taiwan, Hong-Kong and Singapore


0

50

100

150

200

250

300

350

400

450

500

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Tape

ring

QE3

+Dra

gui

Eq. reached by May 2015 (model forecasted pace)

Page 11


-10

0

10

20

30

40

50

60

70

2006

2007

2008

2009

2010

2011

2012

2013

2014

0

20

40

60

80

100

120

140

2006

2007

2008

2009

2010

2011

2012

2013

2014

0

50

100

150

200

250

2006

2007

2008

2009

2010

2011

2012

2013

2014

-45%

+6%

+2%

Turkey: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

Mexico: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

Brazil: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

Russia: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

-24%

Asymmetry in capital flows adjustment remains…

0

20

40

60

80

100

120

140

2006

2007

2008

2009

2010

2011

2012

2013

2014

Page 12


-10

0

10

20

30

40

50

2006

2007

2008

2009

2010

2011

2012

2013

2014

China: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

Thailand: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

Philippines: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

Indonesia: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR

0

5

10

15

20

25

30

35

40

45

50

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

0

5

10

15

20

25

30

35

40

45

50

2006

2007

2008

2009

2010

2011

2012

2013

2014

-14% -10%

-31%

0

20

40

60

80

100

120

140

160

2006

2007

2008

2009

2010

2011

2012

2013

2014

-13%

… with a some particular “damage” to Asia…

Page 13


China: Total Net Portfolio Flows Drivers (External (Global and Regional) + idiosyncratic) Source: BBVA Research

Global Factors dominant when tapering started… increasing role of domestic factors thereafter

75% 25%

60% 40% 35%

65%

40% 35%

Emerging Markets: Total Net Portfolio Flows Drivers (External (Global and Regional) + idiosyncratic) Source: BBVA Research

60% 40%

QE

3 +

Dra

gui

Tape

ring

Page 14


China: Retail Net Portfolio Flows Drivers ( External(Global and Regional) + idiosyncratic) Source: BBVA Research

China: Institutional Net Portfolio Flows Drivers ( External(Global and Regional) + idiosyncratic) Source: BBVA Research

-10

-8

-6

-4

-2

0

2

4

6

8

10

Apr-1

2

Jun-1

2

Aug-1

2

Oct-1

2

Dec-1

2

Feb

-13

Apr-1

3

Jun-1

3

Aug-1

3

Oct-1

3

Dec-1

3

Feb

-14

Apr-1

4

Local Global/Regional Flows T

aper

ing

QE3

& D

raghi

In China institutional flows recovering

-10

-8

-6

-4

-2

0

2

4

6

8

10

Apr-1

2

Jun-1

2

Aug-1

2

Oct-1

2

Dec-1

2

Feb

-13

Apr-1

3

Jun-1

3

Aug-1

3

Oct-1

3

Dec-1

3

Feb

-14

Apr-1

4

Local Global/Regional Flows

Tap

erin

g

QE3

& D

raghi

Page 15


Impact of QE tapering seems bigger in China than in rest of EM (especially for bonds)

Page 16

China Net Bond Inflows: Response of 40 bp reduction in US 10yr & Bund ( in % over baseline, Total Assets Under Management) Source: BBVA Research Capital Flows DLM-FAVAR Model

0.00

0.20

0.40

0.60

0.80

1.00

0 1 2 3 4 5 6

Shock to Bund

Shock to 10y Bill

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

0 1 2 3 4 5 6

Shock to Bund

Shock to 10y Bill

China Net Equity Inflows: Response of 40 bp reduction in US 10yr & Bund ( in % over baseline, Total Assets Under Management) Source: BBVA Research Capital Flows DLM-FAVAR Model

EM Net Bond Inflows: Response of 40 bp reduction in US 10yr & Bund ( in % over baseline, Total Assets Under Management) Source: BBVA Research Capital Flows DLM-FAVAR Model

EM Net Equity Inflows: Response of 40 bp reduction in US 10yr & Bund ( in % over baseline, Total Assets Under Management) Source: BBVA Research Capital Flows DLM-FAVAR Model


EMs have introduce a wealth of measures to contain capital outflows

Decrease in Capital Inflows

Market Absorption

Tighter Macro-

prudential Rules

Targeted Prudential Measures

Capital Controls

Structural and Financial Mkts

Reforms

Fiscal Stabilization

Tighter monetary

policy

FX Reserve

Buffers

Exchange Rate

Interventions

Allow FX Rate

Depreciation

Increase in Interest

Rates

Counter Cyclical

Fiscal Policy

Stricter Capital

Requirements

Limit on Banks FX

Open Positions

Easing Capital Inflow

Regulation

Temporary restrictions

on Capital Ouflow Regulation

Macroeconomic Policy Prudential Measures

Policy options to cope with a sudden deceleration in capital inflows Source: World Bank

Tight

Neutral

Loose

Page 17


Outline

Section 1


Section 2

The FED exit

Section 3

Impact on Emerging Markets compared with China Section 4


Page 18


The fluctuation of reserve increase is mainly driven by capital flows

China: BOP’s situation

Page 19

Net error and omission reflect somewhat growing amount of outflows

Capital controls partially insulate China from external shocks bit it might change with the

deepening of liberalization

China: Balance of payments Source: BBVA Research

USD bn

-100

-50

0

50

100

150

200

250

Dec

-07

Mar

-08

Jun-

08S

ep-0

8D

ec-0

8M

ar-0

9Ju

n-09

Sep

-09

Dec

-09

Mar

-10

Jun-

10S

ep-1

0D

ec-1

0M

ar-1

1Ju

n-11

Sep

-11

Dec

-11

Mar

-12

Jun-

12S

ep-1

2D

ec-1

2M

ar-1

3Ju

n-13

Sep

-13

Dec

-13

Mar

-14

Current account Financial accountCapital account Net error and omissionReserve increase


How should China react?

• Domestic factors increasingly important at explaining China’s reaction to QE tapering

– Capital outflows very influenced by political/business uncertainty

– Bond flows from institutional investors leading specially relevant

• The latest data points to new capital inflows as in the rest of EMs but situation can worsen

– The key is no longer the speed of tapering

– But rather earlier increase in hikes in the US

• Other things given, QE tapering, implies a more restrictive monetary policy in China as sources of liquidity are reduced.

– PBoC can, of course, counterbalance this impact but might not be the right time (trade-off with reforms)

Page 20


Thank you!

Comments welcome

[email protected]

Page 21

Date post:	10-May-2015
Category:	Economy & Finance
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China: What happens when the free greenbacks dry up?

Economy & Finance