Factors Affecting China's International Capital Flows In 2015

International and domestic factors are equally important to analyze and predict China's international capital flows.

In the past, we emphasized the importance of international and domestic factors in the analysis and prediction of foreign exchange occupying, and emphasized the importance of international factors to China's international capital flows.

Emphasizing international factors alone is not to say that domestic factors are not important, but because the popular methods of analysis in the market are more thorough to domestic factors analysis, but generally ignore international factors.

Therefore, we believe that we should focus on the international factors.

The key factor affecting China's international capital flows in 2015 is still the spillover effect of monetary policy in developed countries.

This includes both the impact of the US monetary policy on normalization of interest rate increase and the impact of QQE loose monetary policy in the euro area and Japan.

To analyze the spillover effects of monetary policy in developed countries, we need to establish a stable analytical framework, including what are the intermediary indicators and channels of pmission to emerging economies.

From the latest research findings, the spillover effects of the abnormal monetary policies of developed countries on emerging economies including China are reflected in three intermediary indicators and five pmission channels.

Traditional monetary policies affect long-term interest rates, economic output and inflation by changing short-term policy interest rates.

In this financial tsunami, when the policy interest rate dropped to 0, the traditional monetary policy no longer worked. At this time, the developed countries adopted quantitative easing and forward-looking guidance and other non-traditional monetary policies.

Different from the traditional monetary policy, the three intermediary indicators of the non-traditional monetary policy in developed countries on their national economy and global liquidity are: VIX, risk premium and term premium.

The five channels of spillover effects of non-traditional monetary policies on emerging economies include:

Quantitative easing monetary policy in developed countries may induce the adjustment of monetary policy in emerging economies.

For example, some emerging economies, despite economic recovery, inflation and rising asset prices, still carry out relatively loose monetary policy, partly because of fears that the spread of domestic and foreign spreads will trigger exchange rate appreciation and disruptive international capital inflows.

The quantitative easing monetary policy in developed countries has led to depreciation of the US dollar and Japanese yen, and the appreciation of the emerging economies has brought about large-scale international speculative capital flows.

If the currency of an emerging economy is staring at the US dollar, it needs to intervene heavily to stabilize the exchange rate, leading to an increase in foreign exchange reserves.

Especially if intervention can not be completely written off, it will bring domestic monetary and credit expansion.

This is a mixed channel of risk taking, liquidity and asset price.

Through global financial markets, quantitative easing in developed countries has led to looser global liquidity.

In view of the macroeconomic stability and economic growth of some emerging economies, if the interest rates of the developed countries are at a low level for the foreseeable future, interest rates will also be sustainable at home and abroad.

Quantitative easing will drive international capital inflows into emerging economies with higher interest rates through interest rate trading, pushing up their asset and commodity prices.

In addition, sustained low interest rates and abundant liquidity lead to financial institutions willing to take higher risks in developing and emerging economies to find high-yield assets, resulting in bank risk mismatch.

Helen Ray, a professor of economics at London Business School (Helene Rey), puts forward in the dilemma rather than the dilemma: the global financial cycle and the independence of monetary policy: there is a clear financial cycle in the global capital flow, asset prices and credit growth. There is a strong relationship between the VIX index that measures the panic of investors and the stability of the financial system.

If the VIX index stays low for a longer period, the global financial cycle is on the rise, and the outflow and inflow of international capital will increase. Credit creation activities of international banks will be more active, and leverage and asset prices will rise.

Conversely, during the debt ceiling crisis, the US sovereign rating was downgraded seriously affecting the risk appetite of investors. The VIX index rose from an average of 18 in the first 7 months of 2011 to an average of 35 from August to December, with a huge increase.

This has led to shrinking global international capital flows, slowing credit growth and declining multinational asset prices.

The Fed's purchase reduces the yield of us long term treasury bonds, making international investors look for alternatives with the same period and slightly higher risk adjusted returns, leading to rising asset prices, lower interest rates and a relaxed financial environment in emerging economies.