China’s moves to open financial markets to foreign investors risk a weaker yuan, analysts say

China’s efforts to open up its capital markets to a broader set of foreign investors are expected to lead to greater domestic market volatility and more money flowing in and out of the country, analysts said.

In particular, the exchange rate of China’s currency, the yuan, may weaken further as the People’s Bank of China (PBOC) allows market forces to play a greater role in setting its value, while it focuses on ensuring the greater volatility does not result in excessive market movements.

The measures being adopted by the government suggest the PBOC may be moving towards a yuan foreign-exchange regime that is flexible enough to make China’s capital account more accessible. It seems geared towards encouraging more widespread use of the yuan for transactions and central-bank reserves while guarding against panic-selling and herd behaviour in trading of the currency.

Overseas funds have already started to play a bigger role in the Chinese bond market, increasing the possibility that funds will start to flow out of the country, causing greater currency depreciation. Foreign holdings of Chinese bonds increased by 71.6 billion yuan (US$10.5 billion) to a record 1.68 trillion yuan in August, according to data from the Central Depository and Clearing Co and Shanghai Clearing House. The increased foreign holdings come ahead of the anticipated inclusion of Chinese government and policy-bank bonds in global bond market indices from next April.

More foreign capital is also expected to flow into Chinese equities as global index provider MSCI considers plans to increase the weighting of Chinese A shares in its flagship emerging-market index to 20 per cent next year. Foreign investors continued to buy more Chinese domestically-traded shares than they sold for a seventh straight month. Net inflows came to US$2.6 billion in September, according to BNP Paribas, bringing the year-to-date total to US$37.1 billion even as the trade conflict with the United States intensified.