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Global Investors to Pull $538 Billion in Capital Out of China’s Slowing Economy

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China

Big investors are bailing on China and taking $538 billion in capital with them.

China’s economic growth in the first quarter was 6.7%, a number in line with predictions but the country’s slowest quarter growth in seven years.

As a result of that slowdown, capital outflows have been sizeable as investors’ expectations about China’s economic outlook shift and concerns ramp up about the path of its renminbi, or yuan as it’s more commonly called, the Institute of International Finance (IIF) said in a report Monday.

The unwinding of investments, however, has started to ease.

Net capital outflows are expected to slow to $538 billion in 2016, down 20 percent from $674 billion last year.

“While flows have stabilized in recent months there remain risks that outflows could accelerate again if concerns about RMB depreciation intensify again,” IIF said.

Ongoing outflows could lead to bigger losses of China’s reserves, which could force a shift in its exchange rate management and possibly lead to what the IIF called a “disorderly depreciation.”

“A sharp drop in the RMB would likely spark a renewed sell-off of global risk assets and trigger a flight of portfolio capital from emerging markets,” the report said. “Moreover, a sharp depreciation of the RMB could lead to a round of competitive devaluation in other emerging markets, particularly those with close trade linkages to China.”

And the more investors start to fret about the yuan depreciation, the more likely they’ll be to reduce their foreign assets, and those outflows will mean further pressure on the currency.

The IIF said some progress has been made in “re-anchoring” investors’ expectations of the exchange rate by focusing the yuan’s valuation against a basket of currencies rather than solely pegging it against the dollar.

“Stabilization of the RMB has also been helped by a relatively soft performance of the U.S. dollar against other major currencies,” IIF said. “Pressure on the RMB could rise if the dollar starts to strengthen again but managing against a basket should reduce the need for the People’s Bank of China to support the RMB by allowing for a moderate degree of depreciation against the dollar.”

The unknown, however, is what level China’s currency reserves can fall to before the bank starts to worry. Reserves have already slid from $4 trillion in June 2014 to roughly $3.2 trillion this February, though those numbers would still appear high in comparison to other countries.

Depleting reserves and considerable capital outflows have already prompted authorities in China to tighten restrictions on cross-border flows, IIF said, including interventions to offshore yuan markets to reduce speculative short positions against the currency.

China has always been a large recipient of foreign investment, and from 2000 to 2014 capital inflows reached $3.6 trillion, or 30 percent of total foreign investment inflows.

Foreign investments will continue to leave the country this year and currency pressures will persist. For now, though, things are at least moving in a more stable direction.

Capital outflows in March were around $35 billion, according to IIF estimates, bringing total outflows for the first quarter of 2016 to $175 billion, well below the pace seen in the second half of last year.

“China remains vulnerable to a renewed intensification of capital outflows, particularly if doubts about the stability of the RMB were to come to the fore again,” IIF said. “In particular, stress could rise through a combination of a stronger USD—particularly if the market comes to believe that the Fed will tighten more quickly than currently priced in—and further disappointment about China’s growth momentum.”

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