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?
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
China: What happens when the free greenbacks dry up?
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
China: What happens when the free greenbacks dry up?
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)
China: What happens when the free greenbacks dry up?
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
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 6
China: What happens when the free greenbacks dry up?
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
China: What happens when the free greenbacks dry up?
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 $10bn reduction of QE3
Course of policy firming remains data dependent
Anticipated changes to June projections on “pace of policy firming” due to new, incoming FOMC members
FOMC likely to introduce further modifications to the forward guidance throughout the policy normalization process
Latest What do we expect? Policy pause until
4Q14
Expected End QE3
3Q15
First FFR Hike
1H16
Policy Normalization Balance sheet: let securities
mature/sales
Expected Timeline
for Exit
Strategy Page 8
China: What happens when the free greenbacks dry up?
Outline
Section 1
Global economic outlook
Section 2
The FED exit
Section 3
Impact on Emerging Markets compared with China Section 4
Conclusions for China
Page 9
China: What happens when the free greenbacks dry up?
Page 10
Net Portfolio Inflows : Developed vs Emerging (Country Flows over Total Assets, moving average 3 months) Source: EPFR and BBVA Research
Net Portfolio Inflows : Regional Emerging Mkts (Country Flows over Total Assets, moving average 3 months) Source: EPFR and BBVA Research
QE tapering at first dramatic for EMs but improving
China: What happens when the free greenbacks dry up?
Emerging Markets: Cumulative Net Capital Flows (Cumulative since 2005, US$ bn) Source: BBVA Research, IMF and EPFR
Path of recovery strong but should moderate
Actual: -14% (undershooting)
-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
Actual: -17% (undershooting)
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)
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China: What happens when the free greenbacks dry up?
-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
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China: What happens when the free greenbacks dry up?
-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…
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China: What happens when the free greenbacks dry up?
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: What happens when the free greenbacks dry up?
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
China: What happens when the free greenbacks dry up?
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
China: What happens when the free greenbacks dry up?
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
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 compared with China Section 4
Conclusions for China
Page 18
China: What happens when the free greenbacks dry up?
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
China: What happens when the free greenbacks dry up?
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)
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China: What happens when the free greenbacks dry up?
Thank you!
Comments welcome
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