The race to extract a quarter-trillion dollars from China
Chinese citizens have been clandestinely transferring billions of dollars abroad, evading the scrutiny of authorities, as a declining property market and economic instability compel individuals to seek more secure avenues for their wealth overseas. Transferring wealth from China presents significant challenges due to the stringent capital controls in place, which limit individual foreign exchange purchases to $50,000 annually. Those who contravene the law may face substantial penalties, including hefty fines or potential incarceration.
Nonetheless, the rush to withdraw funds in recent years seems to overshadow the capital outflows witnessed in 2015 and 2016, when a prior downturn in the property market triggered what was then the largest episode of capital flight from China, measured in dollar terms, as indicated by analysts and a review of data from the Wall Street Journal. The Journal’s calculations indicate that approximately $254 billion may have exited China through illicit means in the four quarters leading up to the end of June. This amount surpasses the capital that exited the country nearly ten years prior, a period marked by heightened concerns over a potential financial crisis. Nevertheless, assessments of these outflows remain fundamentally uncertain, and the overall capital flight seems to constitute a lesser proportion of China’s significantly expanded economy today.
It is probable that a portion of the unaccounted funds consists of export revenues concealed overseas, rather than being repatriated to China, to capitalize on more favorable deposit rates and investment prospects abroad. The trend presents a significant concern for Chinese policymakers. The situation intensifies the strain on the currency as authorities concentrate on its meticulous management. Nevertheless, recent efforts to invigorate the economy through stimulus measures are providing support to the yuan and Chinese stock markets, potentially encouraging individuals to retain their funds within China for the time being. It further highlights the diminishing confidence in China’s economic trajectory among those equipped with the means and capability to relocate their capital.
Individuals employ a range of established yet precarious strategies to circumvent governmental limitations, including the overseas shipment of valuables and the excessive payment for imports. Some are employing innovative techniques, such as transporting computer hard drives filled with cryptocurrencies to different jurisdictions for conversion into liquid assets. The exodus can be attributed to the Covid-19 pandemic, stringent government measures targeting the private sector, and pervasive anxieties regarding the end of China’s rapid growth era. The International Monetary Fund projects that economic growth will decelerate to approximately 3% by the decade’s conclusion, down from the current 5% and nearly 7% prior to 2020. Since 2021, China’s monumental property collapse has obliterated an estimated $18 trillion in household wealth, as reported by Barclays.
While Beijing’s recent stimulus initiatives, featuring commitments to increased fiscal expenditure, are expected to provide a modest uplift to growth this year, it remains premature to determine whether they will catalyze a sustainable economic recovery. In the long run, the country confronts a daunting challenge posed by a declining and aging workforce, while simultaneously navigating tensions with the U.S.-led West on a spectrum of matters including trade, security, and technology.
Government officials are endeavoring to set precedents by penalizing those found in breach of regulations. In a September report by state television broadcaster CCTV, Beijing police dismantled a network that facilitated the transfer of 800 million yuan, or approximately $112 million, abroad through cryptocurrency trading. A prior incident in May featured an individual who purportedly held a position at a travel agency while clandestinely running an illicit foreign-currency exchange operation from Beijing, according to reports from Xinhua state media.
The State Administration of Foreign Exchange in China releases documentation regarding individuals penalized for breaches of capital controls. A man with the surname Liu, hailing from Zhejiang, engaged in 48 illicit foreign-exchange transactions amounting to over $3 million from January 2022 to March of the previous year, as reported on the website of SAFE, which highlighted this case among ten similar instances in April. Sanctions may encompass penalties exceeding fifty percent of the financial sum at stake, potentially resulting in criminal indictments.
The ongoing capital flight underscores the lengths to which individuals will venture in pursuit of superior returns, particularly in light of the limited investment prospects available in China, according to Martin Lynge Rasmussen, a senior strategist at research firm Exante Data, who has examined this trend. “Five or 10 years ago, a Chinese individual could invest in real estate as a means to enhance their wealth,” he remarked. “That is no longer appealing in any sense,” he noted, although recent stimulus measures could enhance the allure of domestic stocks as an alternative and assist in mitigating capital flight.
In 2016, China initiated a series of measures to restrict the outflow of capital across its borders. During that period, a downturn in the real estate market, an ailing economy, and depreciation of China’s currency prompted numerous Chinese individuals to transfer their funds abroad. The situation intensified pressure on the yuan, heightening concerns regarding the possibility of a broader financial crisis should investor sentiment shift markedly against emerging markets, particularly impacting banks with significant Chinese asset holdings facing substantial losses. Extracting capital from China has increasingly become a formidable challenge, even for affluent individuals with international ties in prosperous urban centers like Beijing, Guangzhou, and Shanghai, as reported by private bankers and family office personnel in Hong Kong and Singapore.
Currently, financial institutions in Hong Kong impose stringent restrictions on new cash deposits aimed at mitigating the risk of potential capital-control infringements. Private bankers in the city have indicated that customers depositing over $10,000 within a week are required to furnish documentation verifying the source of their funds. In an effort to circumvent regulatory constraints, certain entrepreneurs establish shell companies abroad under the names of family members. These entities are subsequently utilized to secure an interest in enterprises based in China, as reported by sources within family offices that oversee Chinese investments.
This approach enables the China-based firm to be reclassified as a Sino-foreign joint venture, thereby circumventing the government’s restrictions on individual capital transfers. Consequently, its China-based proprietors can remit funds to the offshore entity through dividends and various other payments. However, transferring funds through that method is a sluggish process, according to the individuals involved.
Art presents an alternative pathway. A representative from a prominent auction house indicated that a significant portion of current transactions is conducted by individuals seeking to transfer capital out of China. The approach is straightforward: An artwork or other significant piece is transported to Hong Kong and subsequently auctioned off. Instead of repatriating the proceeds to mainland China, the funds remain offshore in Hong Kong, held in U.S. dollars or another foreign currency. In Hong Kong, where capital controls are absent, the seller is able to transfer funds to other locations.
Cryptocurrencies present novel avenues for capital flight. Despite the prohibition of cryptocurrency trading in Beijing in 2021, the establishment of a crypto wallet remains within legal bounds. In China, individuals have the opportunity to acquire cryptocurrency assets using the local currency, facilitated by intermediaries. Upon acquiring cryptocurrency in their digital wallet, individuals can subsequently exchange those assets for dollars abroad. Estimating capital flight from China was once a relatively uncomplicated task. China, akin to other nations, publishes balance-of-payments data that detail the inflow and outflow of funds within its borders. Typically, international receipts and payments in the data are expected to balance out to zero over a specified period, with only minor discrepancies that tend to resolve swiftly.
In the context of China, the arithmetic not only failed to align, but the discrepancies remained evident—a clear indication that certain funds were escaping unnoticed, unreported. The figures experienced a significant increase in 2015 and 2016, reaching a zenith in the year ending June 2017, amounting to approximately $228 billion. The government reacted by imposing stricter capital controls, leading to a significant contraction in the size of the gaps. As the pandemic unfolded in 2020, there was a gradual increase that escalated sharply in 2021 and 2022, as individuals sought to relocate their finances—and themselves—beyond China’s stringent Covid-19 measures.
The recent data indicates that the disparities have diminished significantly, suggesting a modest inflow into China during the second quarter. However, analysts contend that this perspective is inconsistent with the prevailing pessimism regarding China’s economic outlook. This observation is inconsistent with significant legitimate outflows noted in other areas of China’s accounts, indicating that businesses and investors are pursuing more favorable returns overseas. During the second quarter, net outflows of direct investment reached $86 billion, marking an increase compared to previous years as Chinese companies intensified their efforts to allocate more capital abroad.
Analysts such as Rasmussen from Exante Data and Brad Setser, a senior fellow at the Council on Foreign Relations, attribute the discrepancy to a modification China implemented in 2022 regarding its balance of payments data calculations. The alteration substituted customs data with surveys, a move that some analysts argue diminishes China’s substantial trade surplus and obscures capital outflows.
In a recent statement, SAFE indicated that the adjustment was implemented to “more comprehensively and accurately” assess the nation’s balance of payments in light of evolving trading patterns. Furthermore, external experts have remarked that its methodology aligns with the principles governing international balance of payments data. By recalibrating the data to align more closely with previous calculations, analysts indicate that signs of illicit capital flight resurface. The payments data for the 12 months ending in September 2022 revealed a gap exceeding $370 billion, aligning with the Covid-19 lockdowns imposed in key Chinese cities.
Capital flight, assessed through this lens, has lessened since that period, yet it remained significantly elevated, exceeding $200 billion in the four quarters leading up to June. China’s State Administration of Foreign Exchange noted that discrepancies in the balance of payments are not uncommon for sizable trading nations and do not indicate capital flight.
