China vows to ‘strengthen forex market monitoring’ as capital-outflow risks mount from US Fed moves

Beijing is looking to shore up market confidence to counter the looming threat of economic turbulence after US Federal Reserve says more interest rate hikes will come
A cooling of economic activities and consumption in the US – the third-largest destination of Chinese merchandise – would also affect Chinese exports

China's economic recovery

Frank Tangin Beijing

Published: 11:30pm, 17 Mar 2022

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The US Federal Reserve’s projection for more aggressive interest rate hikes in the coming months has sounded alarms for Beijing, which is trying to shore up financial market confidence and achieve “around 5.5 per cent” economic growth this year, despite a variety of headwinds.

The Fed’s 25-basis-point hike in its short-term benchmark rate on Wednesday – raising the key rate to a target range of 0.25 to 0.5 per cent after two years of holding borrowing costs near zero to insulate the economy from the pandemic – has already prompted China’s foreign-exchange regulator to say it will be more closely tracking cross-border capital flows while trying to help companies defend against forex risks.

And the US move has resulted in hesitation by China’s central bank over how much loosening – including rate cuts – it needs to bolster the economy, while it also tries to avoid disruptions in the stock market.

“We’ll strengthen forex-market monitoring to safeguard its stable operations, and will enhance macroprudential management,” the State Administration of Foreign Exchange said on Wednesday, following an order by the Financial Stability and Development Committee (FSDC) to address market concerns.

“We’ll guide market entities to use exchange-rate hedging tools on a larger scale and actively tackle the risk of external shocks.”

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The People’s Bank of China’s lack of adjustment this week in the interest rate on one-year medium-term lending facility (MLF) loans, as some had expected, means that China’s loan prime rate – set as a spread above the MLF rate – could also remain on hold when it is announced on Monday.

To ensure stability and consistency with policy expectations, the super financial regulator also said any policy that could have a significant impact on the capital market should be coordinated with the financial regulatory department in advance.

And the committee pledged that “market-oriented and law-based” principles would be adhered to in the regulation of the platform economy, to boost its healthy development and international competitiveness.

The US Fed indicated that there will be six more interest hikes for the rest of this year, and the median estimate of year-end rate would put it around 1.9 per cent.

Raising the interest rate is a measure to combat inflation, as it induces people to save more money and serves as a deterrent to consumption spending that drives up inflation.

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Fed Chair Jerome Powell also mentioned that plans to reduce the central bank’s nearly US$9 trillion balance sheet could be finalised by May.

The tightening approach, which will be followed by major Western economies, is one of key concerns haunting China.

It has worsened market woes, as China’s A-share market has plunged around 20 per cent from the start of this year as a result of the Russia-Ukraine war, the China-US spat over the audit of US-listed Chinese companies, and the nationwide spread of the Omicron coronavirus variant.

Major indicators that measure the external environment have also shown signs of deterioration. For example, overseas holdings of Chinese bonds fell by 80 billion yuan (US$12.6 billion) last month after increasing their positions for more than 30 consecutive months.

Stock market sell-offs have also intensified, with a net outflow of 62.4 billion yuan (US$9.84 billion) through the mainland-Hong Kong Stock Connect scheme in the past month, including 16 billion yuan worth of outflows on Tuesday.

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Zhang Yiping, an economist with China Merchants Securities, said outflow pressure is mounting as the interest rate gap between China and the US has narrowed to a relatively low level and will worsen during the US rate-hike cycle.

“Considering the severe situation in cross-border capital flows, the People’s Bank of China may be hesitant to slash [interest] rates in the short term, but its [monetary] easing tone won’t change accordingly,” he said.

The US’ monetary tightening will woo back capital from emerging markets, and this can cause rapid depreciation in the currencies of vulnerable economies.

The yuan also depreciated sharply from 2015-17, and this was stopped only through strict capital-control measures and the burning of foreign-exchange reserves.

Meanwhile, a cooling of economic activities and consumption in the US – the third-largest destination of Chinese merchandise – will also affect Chinese exports.

US-bound merchandise shipments jumped by 27.5 per cent to US$576.1 billion last year, and net exports contributed to 20.9 per cent of China’s gross domestic product growth in 2021.

Beijing this week pledged more policy coordination in addressing market concerns, as well as “substantial measures” to help boost the economy.

And its promise to “actively release policies favourable to markets” has fuelled expectations of further monetary loosening, while its caution in introducing contractionary measures was evident in the Ministry of Finance’s decision to shelve the expansion of a property tax trial.

Zhu Qibing, a macro analyst with BOC International, said global risk-off sentiment often follows the Fed’s tightening moves, but the yuan is unlikely to endure a hit like it felt in 2015. Zhu pointed to flexibility in the yuan exchange rate and smaller exposure to foreign debt, which help absorb external shocks.

The yuan midpoint hit a nearly four-year high of 6.3014 per US dollar on March 1 but weakened to 6.3406 on Thursday.

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Nevertheless, “exchange-rate turbulence could still be seen if changes in global financial market and the geopolitical situation exceed expectations”, Zhu warned.

Yuan Fang, an analyst with Essence Securities, attributed foreign investors’ sell-off to domestic policy adjustments and China’s sharp rise in coronavirus infections, noting that the US rate hike has been anticipated and that yuan remains strong.

“Given the monetary policy divergence – China is poised for loosening while overseas countries embrace tightening – domestic economic prosperity will be vital to offset the pressure of capital outflows,” Yuan said.

China’s 8.1 per cent economic growth last year was a key reason for its record US$173.5 billion inflow of foreign direct investment.

The growth momentum continued, with a 45.2 per cent rise in foreign direct investment to US$37.9 billion in January-February of this year, according to the Ministry of Commerce.