China’s capital conundrum: US Fed hikes and geopolitical strife add fuel to yuan exodus

After another interest-rate hike by the US Fed, and with more to come, China’s central bank is looking to prevent a rapid depreciation of the yuan

Some analysts are calling for Beijing to maintain flexibility in the yuan’s exchange rate, even after it recently crossed a key psychological line of 7.0 yuan to the US dollar

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US Federal Reserve Board Chairman Jerome Powell on Wednesday announced yet another aggressive interest rate hike. Photo: AFP

Published: 8:30pm, 22 Sep 2022

A steady stream of capital outflow from China poses a growing challenge to Beijing and emerging economies that are already struggling to cope with faltering economic growth and a rapid strengthening of the US dollar, according to analysts.

The US Federal Reserve’s third-straight 75-basis-point rate hike on Wednesday raised benchmark interest rates to the highest level since 2008 and further widened the monetary policy gap between the world’s two largest economies.

And with a fourth rate hike possible in November, the pressure on Beijing looks to keep mounting as it strives to prevent both excessive yuan depreciation and a massive exodus of capital.

Between February and July, China suffered a record net outflow of US$81 billion via the Stock Connect and Bond Connect mechanisms, according to data from the Institute of International Finance (IIF). The outflow moderated a bit in August, with foreign investors trimming their holdings in Chinese bonds by 30 billion yuan (US$4.24 billion), according to data from the People’s Bank of China (PBOC).

In total, emerging markets in August posted their first month of inflows – totalling US$27 billion – after five consecutive months of outflows, according to the IIF. In July, net portfolio outflows from emerging markets reached US$9.8 billion.

But the scale of China’s capital outflow is not yet comparable with the exodus recorded in 2015, when the PBOC shocked markets by devaluing the yuan by more than 3 per cent. The IIF estimated that China saw a net capital outflow of US$676 billion in 2015.

Still, some analysts are calling for Beijing to maintain flexibility in the yuan’s exchange rate, even after it recently crossed a key psychological line of 7.0 yuan to the US dollar. And they are pointing to the importance of shoring up economic resilience to help offset external shocks.

The yuan, which has been depreciating against the US dollar of late, reached 7.0853 per dollar in Thursday’s early trade in the onshore market – the weakest level since June 29, 2020 – and closed the day at 7.0810 against the greenback, compared with the previous close of 7.0496.