Dollar rally tests China’s capital controls as liquidity flees

Dollar rally tests China’s capital controls as liquidity flees

Written by Georgina Lee and Summer Zain

SHANGHAI/HONG KONG (Reuters) – Cash is leaving China’s financial markets in their fastest slowdown in years as investors flee a slumping currency and a faltering economy and analysts are pointing to hints of more money moving out of the country along back channels, further indications of low confidence.

The flows, which mostly come out of the bond market, reflect the attractiveness of higher interest rates elsewhere.

But its size and signs that it is spreading out of foreigners’ wallets highlight the fragility of domestic confidence – a potential drag on the yuan going forward – and the magnetic effect of a rising US dollar on global capital flows.

“Everyone is suffering from the storm of rising interest rates in the United States,” said wealth manager Liu Yuan. “US dollar assets are in the midst of the storm. It’s a haven for breeze and sunshine (while) life is tough on the fringes.”

Officially, China’s National Financial Accounts, which cover stock and bond markets and direct investment flows, show that a net $101 billion has been drawn down over the six months through June, putting 2022 on track to record the largest such annual inflows since 2016.

Monthly debt market data shows that foreign investors were net sellers for seven consecutive months through August as what had been a premium to profitable yield in China faded as US interest rates rose.

To be sure, exports mean China’s current account balance remains positive and not every asset class is experiencing outflows – equities attract modest inflows.

But the massive net outflow of $45.2 billion in the balance of payments in the “errors and omissions” category has some economists suspicious that the money is being moved out of the country through illegal or semi-legal channels.

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“Essentially the errors and omissions reflect the informal exit of the population’s money,” said Alicia Garcia-Herrero, chief Asia economist at French bank Natixis.

“Foreign asset managers are no longer just investing in China, it’s the unrecorded outflows that are getting worse,” she said with confidence fluctuating. “People want their money out.”

The yuan has fallen more than 11% against the dollar this year.

Unlike most of its global peers who are tightening policy quickly to tame hyperinflation, China is cutting lending rates to support its sharply slowing economy. The housing market, where most Chinese hold their largest assets, is slowing sharply, and youth unemployment has reached record levels.

Jim Shelter

Amid the exodus of foreign investors, there are signs that locals are following along as quickly as allowed under capital controls that were tightened after the previous season of massive outflows in 2016.

Total overseas investment under the Bond Connect cross-border framework, which links mainland China to Hong Kong and global markets, reached 301.5 billion yuan ($42 billion) at the end of August, up 34% from the previous month and a 19-fold increase since March.

“All asset types are declining this year, and we expect some cash-type products that are pegged to the US dollar,” said Liu Yaolong, marketing director at GaoTeng Global Asset Management, which is promoting such funds for Chinese investors.

Quota-based schemes that allow domestic investors to access foreign markets and products are also increasingly popular.

Subscriptions to the Qualified Domestic Institutional Investor (QDII) program rose 80% in the eight months through August to 322.8 billion fund units.

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A recent HSBC survey also showed that 85% of investors who have funds in foreign products via the cross-border wealth management link scheme, plan to invest more in the next 12 months.

return channels

Signs of unrecorded flows are difficult to detect, and “errors and omissions” data in national accounts are inconclusive. Moving money is also very challenging as COVID-19 restrictions on travel add another layer to capital controls.

However, immigration can provide an excuse to transfer money, and brokers have noted an increase in inquiries about the study.

Data from Education International Cooperation showed a 41.5% jump in inquiries about studying in Hong Kong between January and July, compared to the same period a year earlier.

Family offices abroad can also become hubs for global investment. About 300 new family offices opened in Singapore last year, according to the Monetary Authority of Singapore.

Investors from Hong Kong, Macau and Guangdong Province took up 44% of newly established family offices in Singapore for the first four months of this year, up from 39% in the whole of 2021, according to Singapore’s Chinese-language newspaper Lianhe Zaobao.

Buying insurance products in Macau, where the border with the mainland remains open, has been another popular back channel that is reportedly seeing renewed interest. The products that mainland visitors buy are usually denominated in US dollars, which provides a hedge against yuan weakness, and carries an attractive return in the long run.

Concerned agents say the ongoing shutdowns and uncertainty about the property market in China are also factors besides the weak currency. If they continue to do so, the opening of China’s borders could unleash new inflows and sell-offs of currencies.

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“I wouldn’t say the renminbi’s depreciation is the only reason,” said an agent for insurance company AIA, who asked not to be identified because the topic is sensitive. They expect a rush for Hong Kong products when the border between Hong Kong and the mainland reopens.

(dollar = 7.1741 renminbi)

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