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Foreign cash-stashing by China’s elite strikes worrying note

Stories about the grotesque venality of China's political elite come thick and fast but the revelation that close relatives of President Xi Jinping and of former Premier Wen Jiabao established companies in Caribbean tax havens will have caused some Beijing mandarins to choke over breakfast. The problem is not that the Chinese might wonder whether their leaders are burying cash in foreign hideaways. The big worry is that it might send a message to anyone with savings that it would be sensible to do the same.

The leaked trust company documents, published by the International Consortium of Investigative Journalists and various newspapers, are a name-check of relatives of the current and recent Chinese leadership and members of the People's Congress, the top Chinese legislative body who have allegedly established companies in the British Virgin Islands. While highly embarrassing, the details will not surprise anyone who has followed the drip-feed of evidence about the blood ties between the political and business elite in China.

There is no evidence that there is anything illegal in the ownership of these offshore trusts. However, for anyone with funds invested in the People's Republic, it raises a warning flag about the high risk of capital flight. Although the export of capital from China is restricted, there is ample anecdotal evidence that money is pouring out of the country in large volumes. You can see this in the high-end real estate markets in London where new apartment buildings, built by Hong Kong construction companies, are premarketed to Far Eastern (read Chinese) buyers. You can also see it in reports of a recent surge in business in Macau, the former Portuguese colony in the Pearl River Delta, which has been allowed a semi-autonomous role as casino and fleshpot for mainland Chinese.

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Last June, China Securities Journal, a Chinese government publication, issued its own caution about the risk of capital flight from China due to the tightening of U.S. monetary policy and a rising dollar. There has been an active carry trade of investors borrowing money cheaply in Hong Kong and overseas at low interest rates, funds which are then invested at much higher rates in China's non-bank shadow lending market. The huge and growing importance of these private wealth management funds and the present danger they represent was highlighted at the beginning of January when China's National Audit Office revealed that local government debt had surged by two-thirds to $3-trillion (U.S.) since 2010. Much of this money has been lent by non-bank funds and the big unanswered question is what will happen if, as is expected by some analysts, there is a large municipal default.

The first alarm bells have already rung. Last week, China Credit Trust, a high-yielding 3-billion-yuan fund, said it would be unable to repay its investors at maturity, due at the end of this month. More worrying, Industrial and Commercial Bank of China, the state-owned institution through which the fund was sold, has said it will not step into the breach.

If this fund, which is reported to have been invested in a troubled coal miner, is allowed to fail, it will be the first official insolvency in the shadow lending market. Previously, troubled investment funds have had their liquidity problems smoothed over through intervention by the official banking sector. Yet, it is this unwillingness to allow market corrections to take place that creates fertile ground for booms and busts.

For Chinese investors, these are the immediate risks: Firstly, tightening monetary policy in the U.S. and a rising dollar which chokes off the supply of cheap money offshore. Then, followed by an unruly public-sector bankruptcy in China which leads to a mad scramble towards the exit in the shadow banking market.

In the circumstances, it is scarcely surprising that some Chinese with resources are finding boltholes for surplus wealth in foreign markets. It is less welcome news to discover that this manoeuvre appears to have been widely adopted by the families of the political elite. Capital flight has become an endemic problem for Russia, deterring investors and worsening the country's reputation for corruption and instability. China is at risk of travelling down the same road.

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About the Author

Carl Mortished is a Canadian financial journalist and freelance consultant based in the U.K. With a career spanning investment banking, journalism and consulting for global companies, he was for many years a financial writer and columnist for The Times of London. More

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