China’s capital flows and the RMB: Hawkish FED, slower growth and weak confidence were behind the outflows, but will it change soon?

• China has experienced a roller-coaster ride in capital flows this year as the Fed turned hawkish to tame inflation. In this short presentation, we provide a quick update on the latest drivers and shed some light on future trends. ?
• First and foremost, China’s large trade surplus is the main reason why it manages to keep a rather stable balance of payments notwithstanding the large capital outflows in many aspects throughout the year. From foreign direct investment (FDI) and portfolio investment, most types of capital flows have been negative on a net basis. In other words, China’s large trade surplus has protected China’s forex reserves from falling.

• Still, the strong dollar had led to an expectation of a weaker yuan, causing exporters to stay cautious in converting USD receipts into RMB, especially as the risk-free rate is well above 4%. The negative yield differential when switching to the RMB explains the currency has been weak until recently. The recent surge is not really so much related to better prospects for the Chinese economy but to the expectation of a weaker USD as the Fed eases its monetary policy. There is of course a policy factor from the Chinese government in stabilizing?forex conversion too. ?
• In 2024, China’s capital flows will stay challenging for structural factors, but a more dovish FED will certainly help ease the pressure. The improvement in the tech cycle will also support the trade surplus in goods. However, the slow recovery in outbound tourism means foreign currency demand is still way below the pre-pandemic level, which will put some pressure on the RMB in 2024. ?
• The more interesting trend to observe in the longer run will be whether China’s net FDI will turn positive again and if the trade surplus will be affected by the industrial policies of other governments globally. For now, China is still utilizing its comparative advantage well but its domestic policy and global geopolitical risks could lead to renewed pressure as far as capital flows are concerned.

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