China’s Markets Are Tested by Foreign Outflows and a Falling Currency

HONG KONG—A withdrawal of foreign capital from China and a weaker yuan have prompted comparisons with 2015, when Beijing faced a vicious cycle of outflows and currency depreciation.

China has plugged many of the holes that once allowed its citizens and companies to move money out of the country, making a destabilizing exodus of homegrown funds less likely this time around.

But after years of heavy international buying of yuan-denominated stocks and bonds, some market participants are asking if those foreign flows could dry up, depressing asset prices and the currency. A second pillar of the yuan’s strength is also shaking, as the phenomenal export boom China enjoyed during the pandemic recedes.

In China’s bond markets, April was the third straight month of substantial outflows, data from Chinese clearinghouses show. Over the three months, foreign investors reduced their holdings by about 301.4 billion yuan, equivalent to $45.03 billion.

Foreigners have been pulling out of China’s equity markets, as well, selling a net 33.2 billion yuan, equivalent to $4.9 billion, of Chinese onshore stocks through the Stock Connect trading link with Hong Kong between the start of March and Friday.

The yuan has weakened rapidly since mid-April, after trading in a narrow range for months, and for the year is down nearly 5% to about 6.69 to the dollar, according to FactSet. On May 12 it touched its weakest level in nearly 20 months, beyond 6.82 to the dollar.

“Inevitably, the questions have started. Is this a repeat of the summer of 2015?” analysts at Barclays wrote in a note to clients in late April.

That year, a modest depreciation of the yuan during a stock-market selloff was followed by a rush of capital for the exits. By the end of the year, China had spent about $700 billion of its foreign-exchange reserves supporting the currency.

The Barclays team, however, argued the comparisons were overdone. This time, Chinese policy makers haven’t pumped huge sums of money into the financial system, meaning there isn’t the same excess liquidity looking for a way out. And Beijing has become much better at domestic capital controls, they wrote. That helps explain why a 2019 depreciation past seven yuan to the dollar didn’t lead to major capital flight.

Before the 2015-16 crisis, China’s focus was curbing inflows of hot money betting on a rising yuan rather than stopping outflows, said

Becky Liu,

head of China macro strategy at Standard Chartered Bank.

That meant there were lots of channels for unauthorized outbound payments, Ms. Liu said. But no longer, she said: “These loopholes have now been closed, and outflows under the legitimate channels have been, and will likely continue to be, manageable.”

China’s State Administration of Foreign Exchange said it took a zero-tolerance approach to violation of foreign-exchange rules. The regulator, known as SAFE, said it had stepped up efforts to prevent and control fund transfers through illegal channels.

The pandemic has curtailed tourism, a previous source of household outflows, said Gene Ma, the chief China economist at the Institute of International Finance. And while there are legal routes for individuals to convert money, such as a personal exchange quota of $50,000 a year, banks have a lot of discretion in how they handle these operations, he said.

Chinese policy makers have pledged to support the economy, including the beleaguered internet-technology sector. They have recently taken steps to aid the moribund housing market, such as cutting longer-term benchmark loan rates and making mortgages cheaper for first-time home buyers.

Still, global investors have plenty of reasons for caution. Beijing’s zero-Covid policies are causing economic strains, and the effects of its numerous corporate crackdowns are still reverberating. The yield advantage Chinese bonds offer over U.S. equivalents has evaporated. And China’s reluctance to break with Russia over Ukraine has heightened questions about geopolitical risk.

The outflows are modest compared with overall foreign holdings. As of December, overseas entities held some $1.2 trillion of onshore assets in yuan, data from China’s central bank shows, split roughly equally between stocks and bonds.

The benchmark Shanghai Composite has rebounded about 9% since hitting its lowest point in nearly two years in April, and this past week the yuan regained a little ground. Net stock flows have recently turned positive.

Some international investors are also sounding less pessimistic, suggesting foreign buying could pick up again.

“The outlook for Chinese equities has improved,” said

Andrew Swan,

head of Asia ex-Japan equities at Man GLG. He said the recent yuan selloff wasn’t too large or concerning, and Chinese policy makers realized “now is the time to stimulate the economy.”

Foreign investors’ actions can weigh on domestic market sentiment, said

Guan Tao,

global chief economist at Bank of China International Securities and a former senior SAFE official. But he said China’s trade surplus is sufficient to offset the outflows, and the longer-term movement into Chinese markets would continue.

“China’s financial market has just opened up, and most of the foreign capital is still in the state of increasing allocation,” he said. “A large amount of foreign capital is about to come in.”

The benchmark Shanghai Composite has rebounded about 9% since hitting its lowest point in nearly two years in April.


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Likewise, SAFE said China’s growth remains relatively rapid, with yuan assets offering diversification and comparatively high returns. It said the recent depreciation was mostly driven by international market trends and short-term shifts in sentiment. “The trend of foreign capital’s long-term allocation to yuan-denominated assets hasn’t changed,” the regulator said.

Like Mr. Guan, many market-watchers argue that global investors are likely to remain long-term buyers of Chinese assets. They say the global investment community is still underweight onshore assets, given the size of China’s economy and its markets, and say that Chinese securities help make portfolios more varied.

Others are less sanguine. “Is this reversal a blip or is it a major inflection point? That is the question that is confronting markets right now,” said

Logan Wright,

director for China markets research at Rhodium Group.

Mr. Wright said it is too early to answer that question, or to see if China was also suffering significant domestic outflows. But sustained outflows would be bearish for the currency and Chinese asset values, he said. Already, the People’s Bank of China is having to weigh trade-offs between the internal and external effects of changes in its monetary policy, he said.

In trying to generate robust growth while simultaneously pursuing a zero-Covid approach, China’s government is “fighting a losing battle, and something has to give,” said

Freya Beamish,

head of macro research at TS Lombard.

China is likely to end up expanding the money supply, which it has held relatively steady recently, said Ms. Beamish. That in turn would pressure the yuan, also known as the renminbi.

“Whichever way you cut it, you end up with liquidity being created, either to put a floor under growth or as a result of the fact that growth has slowed and the financial sector can’t take it. Either way, you get renminbi depreciation,” she said. “Capital outflows are a serious risk this year.”

Write to Rebecca Feng at [email protected], Quentin Webb at q[email protected] and Dave Sebastian at [email protected]

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