China capital: foreign investors bailed on bonds to the tune of US$7.2 billion in May

China's slower-than-expected economic recovery has put off foreign investors in Chinese stocks and bonds, analysts said, amid a weakening yuan against the US dollar and rising pressure on capital outflows.

Foreign investors pulled US$7.2 billion worth of funds from Chinese bonds in May, according to a new report by the Institute of International Finance (IIF). That marked the fifth consecutive month of outflows. In April, a total of US$10 billion was withdrawn from Chinese debt, according to IIF data.

Chinese equities posted US$126 million worth of inflows from overseas funds in May, IIF said, compared with April's outflow of US$808 million.

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IIF's data reflects considerable fund-outflow pressure in China's capital markets, particularly in bonds, over the past few months, amid a weaker yuan. The Chinese currency has lost 3 per cent against the US dollar since the start of the year.

"At a time when China's trade surplus remains sizeable, Economist Intelligence Unit interprets the renminbi's underperformance as an outcome of adverse portfolio capital flows," the Economist Intelligence Unit said in a note on Tuesday.

The research firm believes a weaker yuan may help offset growing pressures facing China's exports, while advancing the long-term objective of realising a more liberalised currency regime.

Clifford Lau, portfolio manager at investment bank William Blair, said China's government bonds are generally better bids, given the slew of weak economic releases and expectations of stimulus to support growth, which should put a cap on bond yields from moving higher.

"Outflows from foreign investors on China's government bonds have been going for quite a while, given negative yield pickup versus US rates," Lau said.

"A weakening yuan, however, has little impact on how the bond market performs, as foreign ownership represents a very small portion of the total market capitalisation."

There are growing concerns over China's economic recovery after it abruptly ended its strict Covid-prevention measures late last year.

Weak export data last month, a looming local debt crisis, poor domestic demand, deflationary risks and staggering investor confidence are among the headwinds facing the world's second-largest economy.

Reuters also reported earlier this week, citing unidentified sources close to the People's Bank of China, that a regulatory body overseen by the central bank has asked the lenders to lower US dollar deposit rates.

"While this may help reduce dollar demand onshore to some extent, it will likely have a limited impact on alleviating the yuan's depreciation pressure against the dollar," Commerzbank said in a note on Thursday.

"The negative interest-rate differential between China and the US will remain large. US interest rates will stay high near-term, while China will continue to maintain an accommodative monetary policy stance.

"Some suspect that the move may actually increase offshore dollar deposits and only add to the negative balance of payment pressures for China, and hence pressures on the yuan."

Analysts at Natixis said it has become "increasingly challenging" for China to meet its economic growth target for 2023 of around 5 per cent. Lower interest rates and poor corporate profits are deterring foreign investors from allocating funds in Chinese stocks and debt, the French investment bank said.

"The reopening of China's economy was widely expected to unleash the excess savings that had accumulated in bank accounts during the pandemic. This has not transpired," Natixis said in a note last week.

"The widened US-China yield differentials and worsening growth prospects, coupled with a depreciating yuan, are putting investors off a market that was expected to be this year's darling."

This article originally appeared on the South China Morning Post (SCMP).

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