China faces growing concerns as capital outflow intensifies amid yuan pressures

CHINA: China is currently experiencing a significant capital flight, causing concern among authorities as it places added pressure on the struggling yuan.

The currency is facing multiple challenges, with funds leaving its financial markets, global corporations seeking alternatives to China, and a resurgence in international travel negatively impacting the services trade.

The most recent official data illustrates this, revealing a capital outflow of US$49 billion last month, the largest since December 2015.

This capital exodus has been triggered by sluggish growth in the world’s second-largest economy and a widening interest rate gap with the United States, resulting in the yuan reaching a 16-year low.

The risk is that this currency weakness could further diminish the market’s attractiveness, potentially leading to an acceleration of outflows that could destabilise financial markets.

A similar situation occurred after the surprise currency devaluation in 2015 and during the trade tensions between China and the United States under the Trump administration.

During those times, Beijing had to implement capital controls and increase the funding cost of the yuan in Hong Kong to stabilise the situation.

While authorities have taken various measures to address the current weakness of the yuan, reversing the outflow trend appears challenging.

Natixis SA senior economist Gary Ng reportedly said, “Due to the divergence in monetary policies and the current macro environment, it is unlikely that China has reached the turning point with enough incentives to attract capital back.”

Out of the US$49 billion outflow in the capital and financial account last month, US$29 billion stemmed from securities investments, according to data from the State Administration of Foreign Exchange.

Although there has been some increase in inflows, a larger amount has exited, pushing the balance further into the red.

This capital flight coincides with Beijing’s risk of missing its economic growth target of approximately 5% for the year due to challenges in the property market and declining exports.

Foreign holdings hit a four-year low, record sell-off in Mainland shares, and a deepening direct Investment deficit

Foreign investors have reduced their holdings of Chinese sovereign bonds to a four-year low as of August, while they sold a record US$12 billion worth of mainland shares during the same month.

Additionally, direct investment registered a deficit of US$16.8 billion in August, the worst since early 2016, as Covid restrictions and a crackdown on the private sector discouraged investors.

The slow return of investment is attributed to China’s fragile recovery following the lifting of Covid restrictions and a decline in consumer confidence.

China has consistently faced a deficit in services trade as the number of mainlanders travelling abroad has outpaced the number of foreign visitors to the country.

This trend has been exacerbated by the delayed return of foreign tourists, even though China has fully lifted its Covid restrictions.

The deficit worsened last month due to increased outbound tourism during the summer holiday season.

The Chinese currency has depreciated by more than 5% this year, both onshore and offshore, marking the weakest performance in emerging Asia after the ringgit.

Nevertheless, capital outflows may slow to some extent as China’s economy demonstrates signs of stabilisation.

However, the rate trajectories in the United States and China will play a crucial role in determining the extent of this slowdown, according to Edmund Goh, the investment director of Asian fixed income at Abrdn plc.

Goh remarked, “A lot of the money that was bearish on China’s growth and the yuan have left China in the past 12 months, and we should start to see some stabilisation in capital outflows.”