China Faces Potential $65 Billion Capital Outflow in Stock and Bond Markets Next Year

Potential Capital Outflow from China’s Markets
IIF’s Assessment of Geopolitical Risks

Due to conflicts over the supply chain with the U.S., there are predictions that a capital outflow of $65 billion may occur in China’s stock and bond markets next year.

According to a report cited by the South China Morning Post (SCMP) on the 13th, the International Institute of Finance (IIF) suggests that geopolitical risks and changes in investor sentiment may dampen foreign interest in China’s market next year.

The IIF report data reveals a persistent withdrawal of foreign capital from the Chinese bond market since the start of the year. The IIF predicts that this trend of net foreign investment capital flowing out of China will persist into the following year. They explained that following a substantial fund outflow this year, they expect a net outflow of approximately $45 billion the next year. Additionally, they noted that despite the U.S. Federal Reserve’s pause in interest rate hikes, the dovish approach of the People’s Bank of China is likely to sustain the spread of the high dollar-yuan interest rate.

Factors Contributing to Capital Outflow

The People’s Bank of China, the country’s central bank, has maintained low-interest rates this year to supply liquidity to the stagnant economy. The Loan Prime Rate (LPR), which essentially serves as the benchmark interest rate, is currently at 3.45% for one-year maturity and 4.20% for five years. Since the Fed started raising its benchmark interest rate in March last year, the yuan has been unable to escape a downward trend as the interest rate difference between the two countries has widened. The yuan’s value has fallen by 6.2% compared to the beginning of the year, with the dollar-yuan exchange rate exceeding 7.1 yuan per dollar.

Recovery of Capital Inflows in Emerging Markets
Downside Risks for Chinese Assets

According to the IIF report, the inflow of foreign investor capital into emerging markets outside of China showed signs of recovery, with an estimated $43.4 billion flowing into the stock market last month.

The IIF stressed that “the worsening of relations with Western countries is a significant risk factor negatively impacting Chinese assets.” They mentioned that ongoing worries about de-risking, reshoring, and export controls are expected to persist into the following year, exerting pressure on capital flows. The IIF also observed that as central banks in developed nations soften their hawkish stances, capital inflows into emerging markets, excluding China, are likely to continue. They explained that for China, the escalation of geopolitical risks and shifts in investment sentiment will likely impede the capital inflow.

Expectations for China’s Economic Growth

However, it predicted that “thanks to expectations for stability in China’s housing market and a recovery in demand for exports, China’s real GDP growth next year will slightly exceed the existing consensus at around 5%.”

Meanwhile, according to China’s Ministry of Commerce, foreign direct investment (FDI) in China from January to October fell by 9.4% compared to the same period last year, to 987.01 billion yuan. In the third quarter, the amount of FDI outflow was $11.8 billion more than the inflow.

Negative outlooks on China’s economic forecast, framed by local government debt, delayed innovation in state-owned enterprises, and a stagnant real estate market, are gaining momentum. On the 5th, Moody’s maintained China’s sovereign credit rating at A1 but changed its outlook from stable to negative. Considering the precedent of usually downgrading the credit rating after a certain period following a negative outlook, it can be seen as a de facto downgrade warning. Moody’s lowered China’s sovereign credit rating from Aa3 to A1 in 2016, the first time in 27 years since the Tiananmen Square incident 1989.

By. Hyun Jung Kim