SAFE warns of volatile cross-border capital flows

Rising risks in financial, property sectors may lead to an increase in foreign-currency holdings

China may see greater volatility of cross-border capital flows this year as reforms are accelerated to free up the capital account, the foreign exchange regulator said on Tuesday.

The persistent economic downward pressure as well as accumulated risks in the financial and property sectors may increase the volume of assets held in foreign currencies, increasing capital outflows in the short term, according to a report from the State Administration of Foreign Exchange.

But "China will maintain a capital account surplus in 2015", as world demand is likely to rebound and drive up the country's exports, it said, adding, "the trade surplus will continue to expand."

China's current account surplus reached $219.7 billion last year, a rise of 48 percent from a year earlier, and equivalent to 2.1 percent of total GDP, which is "still within a reasonable range", said the report.

The currency regulator warned, however, that it will keep a close watch on capital flows and said it expects the US Federal Reserve to raise benchmark interest rates in the second half year, which could increase fluctuations in foreign exchange markets, especially in emerging countries.

"The Chinese economy will remain at a medium-to-high growth rate of around 7 percent this year," it said, with economic growth supporting renminbi stability throughout the year.

At the end of 2014, the renminbi exchange rate against dollar had dropped by 0.4 percent during the year, remaining "a relatively stable currency", the report said.

Sufficient foreign exchange reserves, meanwhile, can protect the country against external shocks, it said.

Last year, China's foreign exchange reserves increased by $117.8 billion, 73 percent slower than in 2013. They accounted for 1.1 percent of the total GDP last year, compared with 4.5 percent in 2013.

Total net capital outflows reached $55.7 billion between the second and fourth quarters, following net capital inflows of $94 billion in the first three months of 2014.

Central bank Governor Zhou Xiaochuan said recently that the country is keen to achieve full capital account convertibility this year and make the yuan more freely usable.

The foreign exchange regulator is also working on revising foreign exchange control regulations to accommodate freer capital flows, the governor said.

"Given the relatively tighter controls on domestic residents' outbound investments at present, further capital account opening will likely lead to greater capital outflows as households and corporates seek to diversify some of their assets in foreign currency and overseas," said Wang Tao, chief economist in China at UBS AG.

She also foresees an increase in capital inflows in the form of foreign borrowing, considering the relatively low interest rates and looser liquidity conditions offshore.

Yao Wei, a Chinese economist at Societe Generale, said that "an end of official foreign exchange reserve accumulation will require the central bank to do more to keep liquidity conditions from tightening.

"In the absence of balance sheet expansion, the central bank may need to cut the RRR by nearly 200 basis points in 2015," said Yao.