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Hot money flows could threaten the yuan’s stability. Photo: AFP

China ‘must prevent reversal’ of hot money flows as US kicks off monetary tapering, former official warns

  • Beijing says it has the policy tools to handle the effects of the Fed’s gradual removal of the monetary stimulus it has been providing for the US economy
  • But there are concerns among investors that this could result in a more unstable yuan, with large amounts of cash rushing into and out of the Chinese market
China should be mindful of a potential reversal of capital flows as the US Federal Open Market Committee gets ready to kick off its monetary tapering by dialing back US$120 billion worth of monthly bond purchases, a former Chinese central bank official has warned.

There are rising concerns among investors that the tapering exercise will result in a more unstable yuan, as large amounts of capital – i.e. hot money – will rush into the Chinese market as investors bet on the yuan’s one-way appreciation before the tapering is completed, but then rush out again to take advantage of a stronger US dollar after the tapering is finalised.

There is already an influx of foreign investment in Chinese bond and stock markets.

Despite the Chinese government’s assurances that it was ready to handle the effects of the US’s tapering, Sheng Songcheng, the former head of surveys and statistics at the People’s Bank of China, has warned of likely problems stemming from hot money flows.
[China has] more policy tools than the United States
Prof. Sheng Songcheng

“[Cross-border] capital flows could be first impacted,” Sheng, now a professor at the China Europe International Business School, said during an online lecture held by Tsinghua University on Tuesday. “We must prevent a reversal of capital flows, as the US tapering will narrow the bilateral interest rate gap.

“This is one area where we must make preparations.”

With China opening its finance sector wider, foreign holdings of Chinese bonds increased for 34 straight months, with a net increase of 88.4 billion yuan (US$13.8 billion) in September and a total size of 3.49 trillion yuan (US$545 billion) by the end of September.


The upcoming Fed tapering has evoked the memory of huge market volatility during previous exits of US quantitative easing, including a 2015 stock market rout that erased trillions of yuan from Chinese portfolios, with massive capital outflows and rapid yuan depreciation.

What does a stronger US dollar-yuan exchange rate mean, and why is Beijing worried?

Beijing’s policymakers have acknowledged that large-scale monetary easing in developed economies was necessary to fight the unprecedented pandemic, but they have also complained that the prolonged use of such stimulus measures has ramped up global inflation risks.

Speaking at the Financial Street Forum last month, deputy central bank governor Pan Gongsheng tried to boost investor confidence, saying the impact of US tapering would be controllable because of China’s solid economic fundamentals, well-balanced international payments, and macroprudential tools.

Meanwhile, he assured investors that Chinese authorities have the experience and policy tools to handle potential shocks, are preparing a more flexible yuan exchange rate, and are closely watching cross-border capital flows.

Beijing still has a lid on capital control, and foreign investors can enter the domestic capital market only through the Connect schemes.

The world’s second-largest economy has a different economic cycle than the United States, which results in different policy approaches.

Authorities were relatively swift in ending China’s economic policy easing after they initially contained the pandemic in the summer of 2020, insisting on “normal” monetary policy afterwards.
Today, the country is facing a variety of economic headwinds, including rising costs for small manufacturers, a struggling service industry, and the debt crisis facing property developers.

“A majority of recent economic data was lower than expectations, indicating downward economic pressure. There is a certain likelihood that such downward pressure will last into next year,” Sheng said.

US dollar-yuan exchange rate: what is it and why is it important?

China’s gross domestic product growth slowed to 4.9 per cent in the July-September period, down from 18.3 per cent in the first quarter. The growth rate for the first nine months was 9.8 per cent due to a low comparison base resulting from the coronavirus pandemic last year, and was higher than the full-year target of 6 per cent.

Sheng said China needs to increase fiscal support, for instance by accelerating the issuance of local special-purpose bonds, to counter the decline in economic growth.

About 2.74 trillion yuan worth of local special-purpose bonds were sold in the first 10 months, or three-quarters of the annual plan, including 537.2 billion yuan issued in October, government data showed.

Despite refusing to attempt a US-like economic stimulus, Chinese authorities are widely believed to be coordinating with supportive fiscal policies in the country’s cross-cyclical adjustments.


“China has relatively ample monetary policy tools to counter [external and internal shocks]. We have more policy tools than the United States,” Sheng said.