Global investors have withdrawn money out of China on an “unprecedented” scale since Russia invaded Ukraine in late February, according to a report by the Institute of International Finance (IIF), with the yuan likely to face more pressure in coming months. Large portfolio outflows from Chinese stocks and bonds were reported, even as flows to other emerging markets held up, the IIF wrote in a report. “Outflows from China on the scale and intensity we are seeing are unprecedented, especially since we are not seeing similar outflows from the rest of the emerging markets,” said the IIF report. “The timing of outflows – built after Russia’s invasion of Ukraine – suggests foreign investors may be looking at China in a new light, though it is premature to draw any definitive conclusions in this regard.” According to China Central Depository and Clearing, a depository for government bonds, overseas investors’ holdings of Chinese onshore bonds fell by CNY67 billion in February.
“It’s likely that the outflows will be even larger in March,” according to Macquarie Capital. In the first 21 days of March, China also saw net outflows of CNY59 billion through the north-bound Stock Connect program with Hong Kong, although the total amount was smaller than the CNY70 billion of fund outflows in March 2020, the Macquarie report noted. Analysts expect fund outflows in yuan-denominated assets to remain volatile in the coming weeks, raising concerns about how the People’s Bank of China (PBOC) will manage the yuan amid predictions that another rate increase by the U.S. Federal Reserve to tackle inflation could exacerbate outflows from emerging markets and weaken currencies. Freya Beamish, head of global macro at London-based research firm TS Lombard, said that China’s “stubborn” management of the yuan would test the acceptable lower limit of GDP growth. “Prolonged weak growth would in any case lead to yuan depreciation eventually,” she said. “If the authorities are not able to get creative about creating liquidity, China is headed for its equivalent of a recession.”
The country’s foreign exchange reserves, the world’s largest, fell to USD3.214 trillion at the end of February from USD3.222 trillion, despite a strong yuan exchange rate with the dollar. Credit demand was much weaker than expected in February as new bank lending in China fell to CNY1.23 trillion, down sharply from a record CNY3.98 trillion in January, raising pressure on the central bank to ease policy further to support the slowing economy. Beijing has set a growth target of “around 5.5%” for 2022. China’s economy in the first quarter is expected to reflect damage from its worst coronavirus outbreaks in more than two years, as new infections have climbed over the past few weeks. “As it is already the end of the first quarter, the risk of quarterly GDP growth falling short of 4% has been on the rise. If that is the case, the entire year’s growth target of 5.5% would be facing tremendous uncertainties as well,” according to Commerzbank.
Already, U.S. moves to tackle inflation have resulted in hesitation by China’s central bank over how much loosening – including rate cuts – it needs to bolster the economy, while it also tries to avoid adding pressure on the yuan. China’s yuan appreciated slightly to 6.3585 per U.S. dollar on March 25, rebounding from a 10-day low on the previous day. Swiss bank UBS said in a note that it expected China to allow “limited” depreciation of the yuan. “The limited yuan depreciation in all cases is in part due to UBS's global view that the U.S. dollar will weaken from current levels, but also because we believe the Chinese government would not want to see significant currency depreciation and is likely to tighten controls on capital outflows if necessary to slowdown the depreciation,” UBS said.
The State Administration of Foreign Exchange (SAFE) said it would track cross-border capital flows more closely while trying to help companies defend against forex risks. “In any case, the pressure for capital outflows does increase this year, due to the FED hike cycle and the war. As a result, we expect the yuan to weaken modestly to 6.5-6.6 against the U.S. dollar toward the year-end,” said Larry Hu, Chief China Economist at Macquarie Capital. “That said, the elevated trade surplus and the large dollar pool built by Chinese banks and corporates over the past couple of years could help cushion external shocks. As a result, the pressure from capital outflows would not constrain the policy easing this year,” according to Macquarie Capital, as reported by the South China Morning Post.
