MNI INTERVIEW: CNH Signals Capital Outflows - Ex SAFE Official

The recent underperformance of the offshore yuan is a sign that foreign investors are beginning to sell Chinese assets, a former senior official at the country’s foreign exchange administration told MNI, adding that there is a danger that portfolio outflows could weaken the currency if western central banks tighten monetary policy more abruptly than expected.

The offshore CNH rate has closed lower than the onshore CNY every day since the beginning of March, with the spread between the two hitting 360 pips last Friday, the highest since June 2021 in a sign that overseas investors could be selling mainland Chinese assets and exchanging the proceeds for dollars in Hong Kong, said Guan Tao, a former director general of Balance of Payments at SAFE.

This month’s yuan depreciation has been mainly driven by CNH weakness, rather than led by the CNY fixing set by the PBOC, he noted.

The currency could come under more pressure, together with the country’s equity and bond markets, and perhaps even reverse its rally since 2020 if the Federal Reserve and the European Central Bank surprise markets with their pace of tightening, said Guan, now global chief economist at BOC International. About 70% of the net CNY10.8 trillion of yuan-denominated assets held by foreign investors are stocks and bonds, he said.

TRADE SURPLUS SEEN LOWER

The Mainland China-Hong Kong Stock Connect scheme has seen CNY50.7 billion in capital outflows in six consecutive trading days since March 7, including CNY14.4 billion on March 14, the most since Jan. 27, according to financial data provider Wind. Overseas investors also cut Chinese bond holdings by CNY67 billion in February, the first such reduction since November 2018, according to China Central Depository and Clearing Co. Ltd.

Other factors supporting the yuan may also change, including China’s large recent trade surplus, said Guan, adding that Chinese exporters may also be holding on to more of their foreign exchange earnings in order to hedge FX risk. China’s banks sold a net USD27.8 billion worth of yuan in January, almost half the USD46 billion in December and versus USD40.8 billion last January, according to SAFE data.

The yield spread between 10-year Chinese-government bonds and equivalent U.S. Treasuries is likely to further narrow from about 70 bps currently, falling out of the 80-100 bps “comfort range,” said Guan.

But Fed tightening in line with market expectations should produce moderate capital outflows and only healthy two-way yuan trading, Guan said. China’s private sector external liabilities fell by USD1 trillion to the end of September, compared with June 2015, equivalent to a manageable 8% of gross domestic product, he said.

Some yuan strengthening in February was prompted by Russian investors reacting to sanctions, but the currency is still not a safe haven asset on the level of the dollar or the yen, Guan said.