Reasons You Shouldn’t Worry About Money Flowing Out of China

Emerging economies face a long-standing risk: At the first sign of trouble, investors—and their money—head for the exits, with serious consequences for the currency, financial markets and growth. And China, whose capital outflows reached a total $1.7 trillion for 2015-2016, has given investors reason for concern.

There is reason for optimism in the face of those concerns. China, the world’s second largest economy, is different. Not all of the money exiting is fleeing trouble. Much of it has been to buy know-how and other essential building blocks for the foundation of China’s evolving economy. And in a lot of ways those outflows can be an escape valve helping to deflate bubbles.

One way to see how the outflows might not be problematic is to look at the kinds of deals China’s companies are making. Chinese state-backed and private firms snapped up global assets at a record pace last year. To be sure, not all the investments will prove successful. Yet China’s deal activity used to be centered around securing commodities; now, brands and patents top the shopping list.

Here are some of the biggest deals by value:

Then there’s foreign debt. Fluctuating currency markets always pose a risk for emerging economies, as borrowers who have U.S. dollar debt are left at the mercy of a weakening local currency. But in China’s case, the weaker yuan put a brake on a spike in dollar borrowing as companies opted instead to pay down foreign debt before the currency fell further. As a result, they’ve mitigated another key risk associated with capital outflows.

As authorities enforce strict rules on moving money into and out of the country, the excess liquidity ends up sloshing around financial markets as speculators try their luck in domestic stocks, commodities and housing. The end result often isn’t pretty. Allowing some money to leave takes heat out of the markets.

China maintains the world’s biggest stash of foreign exchange reserves, which it can use to defend the currency during periods of market stress. When the yuan wobbled during 2015 and 2016, authorities spent hundreds of billions in dollar terms defending it. That pressure has eased dramatically in recent months, allowing the reserves to be rebuilt.

Strict curbs on the movement of money have slowed the exodus. The pressure that remains will build if the yuan weakens as the Federal Reserve continues to raise interest rates.

When companies move money out of China, it prompts the central bank to ensure the economy has enough cash to keep growing. Let’s look at an example. Say an engineering firm buys a U.S. rival for $1 billion. The company will sell yuan to buy dollars for the deal. Keen to keep the currency stable, the People’s Bank of China steps in to sell those dollars and buy up the yuan, draining money from the economy as a result. To offset that, the central bank has been finding ways to pour that cash back into the domestic economy through new lending tools.

Even at the peak of the capital outflow scare, China still had significant buffers, such as hefty trade surpluses and the robust current account position that resulted. They would prove handy should the markets turn volatile again.

For sure, there are ways for households to squirrel money out. Overseas tourism is one channel used to disguise outflows, according to research by the Federal Reserve. So much so that China’s current account surplus could have been around 1 percent of gross domestic product higher than officially reported in 2015 and 2016.

There are other risks too. If the Fed continues to lift interest rates and the dollar rallies or China’s economy turns sour, the yuan will feel pressure to weaken. That will test the optimists’ theory.