China: Heightened pressure on capital outflows in Q3 2018 and beyond due to increasingly divergent monetary policy

• Natixis China Capital Flow Tracker shows China’s net outflows have further widened in Q3 2018 to 73 USD billion. Given 92% of the outflows were denominated in USD, China could face higher pressure in its slow and steady accumulation of foreign reserves in the future.
• The divergence of monetary policy between the FED and the PBoC will continue to induce capital outflows from China. Poor GDP and weak PMI figures released in October are pointing to additional fiscal stimulus. And China will continue to use monetary conditions to support growth beyond the 250 bps RRR cuts this year and additional targeted lending.
• As a result, the benchmark of 10 Year US-China sovereign yield differentials narrowed to 38 bps in October 2018, the lowest point in recent years. Our Natixis China Bond Indexes also show the difference in onshore-offshore funding costs for Chinese firms had reverted from 46 bps in 2017 to -178 bps. A cheaper cost of funding is supporting onshore bond issuance, which reduces inflows as corporates are no longer swapping back as many proceeds from their offshore issuance.
• On the back of shrinking interest rate differentials with the US, pressure on capital outflows and RMB depreciation are mounting in the short run.

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