Carry Trade Outflows A Powerful Force

Two months ago I posted a Chinese article which estimated the amount of hot money in China: Why the Yuan Must Devalue: $700 Billion in Short-Term Loans Betting on Yuan Appreciation & Rate Arbitrage; One-Third of Reserves Is Hot Money.

The Bank of International Settlements sees the same impact, but draws the wrong conclusion.

Reuters: Carry trades at heart of China capital outflows: BIS
Heavy outflows of capital from China have mainly been a result of the unwinding of carry trades aimed at benefiting from rising interest rates and an appreciating yuan, the Bank of International Settlements (BIS) said on Sunday.

The study in the regular quarterly report by the central banks' central bank also said that capital flight from the yuan, also known as renminbi, had tended to be about the repayment of dollar-denominated debt by Chinese companies rather than widespread sales of mainland assets.

That might point to a reduction of the pressure that has forced China to use hundreds of billions its huge foreign currency reserves to fend off deeper devaluation of the currency.
The debt isn't dollar denominated because the Chinese company didn't borrow the dollars, it owes money to its offshore subsidiary which obtained the capital via short-term loans from offshore banks.
The other key point that seems to be overlooked is that this was not currency arbitrage. A rising yuan made this trade more attractive, but it was fueled by high returns from WMPs, it was about arbitraging low USD loan rates and high Chinese shadow banking interest rates. Even if the currency stabilizes, changes in interest rates will generate outflow pressure.
Source: 金牛理财网
The average non-guaranteed WMP yield was more than 6 percent in 2014. Rates have been falling in China, dropping the yield down almost 2 percent, while rising interest rates and rising credit risk in the U.S. has lifted the yield on investment grade corporate bonds close to 4 percent. Toss in yuan depreciation risk and the trade is a no brainer.
These interest rates arbitrageurs are heavily short USD and they didn't think they were making a currency bet. They want out.

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