Broker's View

China’s growing capital outflows could be down to asset diversification, not panic

Analysts also suggest foreign investors may have regained their appetite in yuan assets

PUBLISHED : Thursday, 27 October, 2016, 11:26am
UPDATED : Thursday, 27 October, 2016, 10:56pm

Chinese households and companies are moving money abroad at a faster pace, with September’s estimated capital outflows hitting the highest amount since February.

But it may not be as alarming as some believe, as the outflows are partly due to more strategic factors, such as the asset diversification by households, analysts said.

China’s capital outflows may have risen to US$142 billion in the third quarter of this year, with US$43 billion in July, US$44 billion in August and forecasts US$55 billion for September, which would represent the biggest amount of capital outflow since February, according to Capital Economics.

“Our estimates suggest the latest pick-up in outflows has been driven by a step-up in purchases of foreign assets by Chinese firms and households, ” said Julian Evans-Pritchard, a China economist for Capital Economics.

He expects outbound portfolio investment in September may have reached US$17 billion, up from US$7 billion in August.

“They (Chinese households and firms) are no longer adding to FX deposits. But there has been a surge in their holdings of offshore securities, as southbound flows via the Shanghai-Hong Kong Stock Connect Scheme hit a record high last month,” he said.

Outbound direct investment flows continue to grow, too, up to an estimated US$26 billion in September from US$23 billion in the previous month.

The increase in capital outflows seems to be in a contrast to foreign investors’ higher demand for yuan-denominated assets.

“After pulling money out of the country during the China panic a year ago, foreigners

are now once again a source of capital inflows,” said Evans-Pritchard.

According to his forecasts, foreign liabilities – a measure of how much foreign money has flown into the economy – may have increased to US$15 billion in September from US$12 billion in August and US$3 billion in July.

After pulling money out of the country during the China panic a year ago, foreigners
are now once again a source of capital inflows
Julian Evans-Pritchard, China economist, Capital Economics

“Foreigners are no longer significantly reducing their holdings of RMB deposits and have stepped up their purchases of onshore securities,” he said.

Inbound portfolio investment, which means foreign investors buying financial assets like equities or bonds, was US$5 billion for September and August separately, up from US$2 billion in July.

Although Chinese officials have pinned the increased demand for yuan assets on the currency’s inclusion in the IMF’s SDR basket, he said it “has much more to do with” China’s earlier move to open up the country’s onshore bond market to foreign investors.

However, he added inbound direct investment remains weak by past standards, only amounting to US$28 billion in the third quarter, down significantly from US$44 billion in the same period in 2015. It’s also lower than the US$34 billion recorded in the second quarter this year.

Analysts from HSBC also agreed capital outflows picked up last month based on their calculations, in a new report published on Thursday.

“All of them (our ways to gauge outflow pressure) paint a consistent picture of deterioration in September compared to the second quarter and July-August,” said Paul Mackel and Joey Chew, analysts at the UK bank.

However, they argued it may not be “as insidious as some believe”.

“Some market participants believe the recent rise in RMB outflows is to circumvent ‘window guidance’ from the authorities that had curtailed purchase and/or transfers of USD onshore,” said Mackel and Chew. “But we do not entirely agree.”

They said some of the outflows are not due to the “opportunistic” depreciation expectations for the yuan, but because of the need by Chinese households and companies to diversify their assets, which they called “a structural and medium-term phenomenon”.

Besides, they said some outflows may have returned onshore via the RQFII (RMB Qualified Foreign Institutional Investor) channel, as there has been increased demand for onshore yuan assets by foreign official and “real money” investors, which differ from hedge funds and refer to traditional institutional investors like mutual funds and pension funds.

On Thursday, the offshore yuan fell sharply against the US dollar in Hong Kong, briefly breaching the critical level of 6.79 to hit a fresh six-year low of 6.7920. It reached 6.7913 per dollar as of 6pm in Hong Kong.

Earlier in the day, the People’s Bank of China lowered the yuan’s daily reference rate by 31 basis point to 6.7736. Traders are allowed to trade up to 2 per cent either side of the reference rate of the day.