Capital Flows Signal Bearish Sentiment on China

An influx of speculative capital, known as “hot money,” has for the last several years allowed China’s foreign exchange reserves to continue growing despite a shrinking trade surplus. The Wall Street Journal’s Tom Orlik, however, highlights recently released data on cross-border capital flows which shows that China’s banks were rare net sellers of foreign currency in October, and explains why the data may indicate a souring outlook on China’s economy:

Indeed, the numbers normally suggest that in addition to the trade surplus, banks are buying up speculative capital flowing into the economy. Tuesday’s numbers suggest that now speculative capital might be exiting China. That makes sense given diminished expectations of yuan appreciation, falling property prices and a deepening crisis in Europe pushing investors away from risky positions.

A comparison with past occasions when hot money has flowed out of China provides little reassurance. Netting out the trade surplus from banks’ FX purchases gives a rough approximation of the scale and direction of capital flows. The last time it turned negative was May 2010, when fears of a double dip downturn were on the rise. The time before: the eve of the financial crisis in August 2008.

See also CDT Money’s coverage of the Chinese economy and increasing signs of a slowdown, including tumbling Chinese real estate prices and Hu Jintao’s recent pledge to boost imports to offset weakening demand for Chinese exports.