People’s Bank of China Governor Zhou Xiaochuan already has one policy headache with the currency falling to near an eight-year low. He could have an even bigger one next month.

That’s when a $50,000 cap on how much foreign currency individuals are allowed to convert each year resets, potentially aggravating capital outflow pressures that are already on the rise. If just 1 percent of China’s almost 1.4 billion people max out those limits, that’s an outflow of about $700 billion -- more than the estimated $620 billion that Bloomberg Intelligence estimates indicate has already flowed out in the first 10 months of this year.

Middle class and wealthy Chinese have been converting money into other currencies to protect themselves from devaluation, exacerbating downward pressure on the yuan. Outflows could intensify if Federal Reserve interest-rate hikes fuel further dollar appreciation.

That leaves Zhou in a bind identified by Nobel-prize winning economist Robert Mundell as the “impossible trinity” -- a principle that dictates nations can’t sustain a fixed exchange rate, independent monetary policy, and open capital borders all at the same time.

"At a moment like this, you have to compare two evils and pick the less-worse one," said George Wu, who worked as a PBOC monetary policy official for 12 years. "Capital free flow may have to be abandoned in order to maintain a relatively stable currency rate."

Eoin Treacy's view

The $50,000 limit of foreign transfers is per person, so a family with two parents, one child and four grandparents can send $350,000 overseas with no need to resort to more sophisticated methods of transferring funds. There are of course many alternative routes to sending money overseas. So far rules aimed at controlling flows have focused on corporations and purchases of foreign real estate in the order of $1 billion but the flow of retail funds on aggregate represents a very large figure overall. 

The Renminbi remains in a consistent downtrend and while the move to date has not been particularly large it has certainly reversed the previous decade-long process of appreciation. The basis of China’s ability to tackle its bad loans problem rests with the massive savings Chinese consumers sitting in low interest deposit accounts at the nation’s lenders. These funds come close to topping the quantity of money the government has in reserve and act as ballast for the financial system as overcapacity in the basic resources, infrastructure and heavy manufacturing sectors is tackled. 

The FTSE China A600 Banks Index has been relatively inert following last year’s fireworks but has held a progression of higher reaction lows since January and a sustained move below 12,700 would be required to question medium-term scope for additional upside. 

The Dollar is somewhat overbought relative to the Renminbi at present. It has tended to pause in the region of the round numbers like CNY 6.4, 6.6, 6.7 and is now paused close to 6.9. A sustained move below the trend mean would be required to question medium-term dollar dominance.