China’s yuan ‘far from a top global reserve’, as investors dump assets amid Ukraine war

The first three months of the year were the worst quarter on record for capital outflows from China, according to the International Institute of Finance (IIF)
Lockdowns, yuan depreciation and perceived risk of investing in countries whose relationships with the West are complicated explain the outflows, IIF says

Yuan

Amanda Lee

Published: 6:30pm, 4 May 2022

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The yuan is still a long way from becoming a global reserve currency after a sharp sell-off of Chinese assets following Russia’s invasion of Ukraine, according to the International Institute of Finance (IIF).

Investors began dumping Chinese equities and bonds after the war started in late February and continued the sell-off throughout March, making the first three months of the year the worst quarter on record for capital outflows from China, the IIF said in a report on Tuesday.

Outflows continued well into April, affecting both Chinese bonds denominated in foreign currencies and the yuan, the IIF said.

“The former probably reflect concerns around real estate developers. The latter were the largest and the ones where the global geopolitical background matters the most,” said the Washington-based trade group representing the financial services industry.

The yuan still seems far from a top global reserve asset

International Institute of Finance

The report also looked at whether Moscow had sold its roughly US$70 billion in reserves held in Chinese assets after major Western economies froze Russian central bank assets, and whether this had contributed to the outflows.

The IIF said that while Russia might have used its yuan-denominated assets in the second half of February, large sales were less clear in March, because reserves were stable.

Some US$300 billion of Russia’s foreign currency reserves are frozen as a result of Western sanctions.

“We think a combination of Covid lockdowns, depreciation, and perceived risk of investing in countries whose relationships with the West are complicated explain capital outflows from China. As a corollary, the yuan still seems far from a top global reserve asset,” said the IIF.

Capital flight puts China on alert for ‘spillover effects’ from US rate hikes

Despite being the world’s second largest economy, the yuan is not widely used outside China.

The currency made up around 2.79 per cent of global foreign exchange reserves in the last quarter of 2021, according to the International Monetary Fund.

The yuan has come under growing depreciation pressure as China battles its worst coronavirus outbreaks in two years.

China’s commitment to eliminate the virus has brought about supply chain disruptions and hurt consumer sentiment, ratcheting up pressure on the slowing economy.

Besides weaker sentiment among investors about Chinese assets, the yuan has turned from bullish to bearish among importers and exporters, UBS said in a research note on Tuesday.

Initial indications suggest there might be less conversion from foreign currencies to the yuan in April compared with March, although the Swiss bank said it would need more data to confirm the trend.

“Meanwhile, the foreign exchange purchase ratio, the conversion of yuan to foreign exchange, rose sharply in March to 68.1 per cent, the highest level since the third quarter in 2019,” UBS said.

“Relative strength of the yuan meant that hedging positions were light until about two weeks ago, and many exporters may have also been caught off guard by the latest move. As more market participants hedge the risk of further yuan depreciation, this could add to the momentum of the yuan depreciation.”