Quiet Capital Outflows from China

Ichiro Suzuki China’ renminbi (RMB) is weak lately. After having approached 6.3 against the U.S. dollar, the RMB has shifted its direction to the downside. In early September, it is getting close to 7, the level last witnessed before the outbreak of COVID-19. This weakness is little to do with Beijing’s intention to promote exports. It is rather strongly attributed to the Federal Reserve Bank’s determination to ‘normalize’ monetary policy that unwinds an overdose of liquidity in response to the pandemic’s outbreak. On top of the Fed’s monetary policy, there is also a Chinese side of a reason behind the RMB’s skid. The People’s Bank of China is slashing interest rates as opposed to the Fed’s hiking. The Chinese economy is decelerating though it still posts higher growth rate than those in developed economies. The real estate and investment sectors, which combined account for roughly a third of the economy, have at last come to an overstretched point where they are no longer able to carry the world’s second largest economy. According to the Financial Times, fixed asset investments grew 5.7% for the first seven months of 2022 over the same period in 2021, compared with an average of 17.8% between 1996 and 2022. Spectacular growth in this segment of the economy has always been funded by borrowed money. Today, over-stretched developers are struggling to service their debt obligations, and they are defaulting on the bonds they issued outside of China. Gone are they days when pictures of Shanghai skyscrapers pinned down on the wall of a broker branch in the developed world solicited a large amount retail money into Chinese equities mutual funds. In the first decade of the 21st century, China’s future seemed limitless. In 2022, limits are being recognized and they appear to be a great deal lower than what was once believed and what President Xi Jinping still speak about. In fact, China’s stock markets did absolutely nothing in the 2010s in contrast to surging Wall Street. Market participants began to understand that state-owned enterprises, which account for over a half of the Chinese market, are not run for shareholders. It was still believed that China’s dazzling tech sector can carry the market amid lackluster performances from SOEs, until the Communist Party began to attack Alibaba and Jack Ma ten months ago. Alibaba still was originally believed to be an isolated incident. Then, Xi started his full-fledged assault on the tech sector under the ‘common prosperity’ slogan, wiping out trillions of dollars in shareholders’ value. Such developments gave global investors ample reasons to shun China. Empty talks about China’s bright future no longer entice inflows of portfolio investments. On the long-term capital front, even Germany AG was reportedly aware of their over-dependence on China by the end of the last decade. Then the pandemic’s outbreak brought the corporate world wholesale reviews of their global supply chains. Before COVID-19, rising wages and costs were forcing Western multi-national corporations to have second thoughts on making things in China, anyway, and off-shoring was already a hot political issue in the 2016 U.S. Presidential election. Then the pandemic has triggered a distinct directional change. Re-shoring is bringing back factories from China back to MNCs’ own soil where the customers are close, or closer such as Mexico in the case of U.S. multi-nationals. ‘Friend-shoring’ is bringing manufacturing facilities to like-minded countries, to get out of a land of one-party rule by the Communist Party to countries under democracy or at least not under autocracy. These new trends are not yet pronounced, but both short and long term capital is flowing into China at a much slower rate than explosive growth witnessed in 2005-15. Having reached $4 trillion in the middle of the last decade, China’s foreign exchange reserve is down at $3.27trillion at present and is growing only modestly. It is believed that some U.S. dollar positions were sold to stem the fall of the RMB when household sector money that was anxious to get out of the country caused intense downward pressure on the Chinese currency. China’s holding of U.S. Treasury securities at $967 million today is considerably smaller than Japan’s $1,236 million. China’s ambition to promote the RMB to rival the greenback in international trade probably has much to do with the size of Treasury securities holding. If Beijing is buying Japanese government bonds in place of T-notes, this politically-motivated transaction is proving to be very costly. The Communist Party’s obsession with stability is likely to make them fight against any material downward pressure on the RMB in the event of the currency’s sharp depreciation, to waste FX reserves. The RMB could come under pressure especially when rich Chinese people try to let their trapped money leave the country en masse. With the real estate market in shambles and stock markets in the doldrums, there is no shortage of grievances among well-off citizens about a lack of return opportunities inside China. China has lost its luster that once captivated investors around the world. Capital flowing into China is no longer abundant whereas there is no shortage of money wanting to leave. While downward pressure is still subtle, an exodus could be triggered any moment.


About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.