Foreign investors continued to reduce their holdings of Chinese bonds in May for the fourth consecutive month. Divergent monetary policy between the United States and China, along with a weakening economic fundamental, has driven foreign investors out of China en masse.
And unlike Chinese sell-offs over the past decade, foreign investors no longer find Chinese investments more attractive on a risk-adjusted basis compared to developed markets.
Chinese yuan-denominated bonds suffered continued declines according to official data from China Central Depository & Clearing Co. Capital outflows also hit the yuan, hitting its lowest relative value in nearly two years. Since last June, the yuan has lost 3.5% against the dollar.
Over the past decade, the Chinese Communist Party (CCP) has courted foreign investors by gradually opening up its huge financial markets to foreign investors. This is partly to offset outflows of capital; Chinese companies and households sent money overseas to acquire foreign assets such as real estate and business investments.
Global investors were happy to oblige. Turning a blind eye to China’s totalitarian regime and its human rights abuses, foreign investors have sent dollars to China both to invest in monetary assets and to set up local businesses to tap into the Chinese market. For a time, Chinese markets provided some diversification, with Chinese bonds offering higher yields during periods of near-zero bond yields in the West.
In many ways, foreign investors have been there to bail out Chinese markets time and time again over the past decade.
But things quickly changed. Foreign investors are leaving in droves and there is little reprieve in sight.
Driven by increasingly divergent central bank policy, US Treasuries now offer a higher yield than their Chinese government bond counterparts. China’s economy, rocked by ongoing COVID-related shutdowns, is in its worst shape in decades with declining consumer and business confidence. And finally, China’s unwavering support for Russia’s invasion of Ukraine has increased geopolitical risk for companies operating in China. Will China try to annex Taiwan in the near future? This is a question companies investing in China need to ask themselves.
There are some signs that the selling is easing, especially in the Chinese stock market. But in this economic environment, where fundamentals are far from stable and it’s only a matter of time until the next COVID lockdown is enacted, investors are pessimistic that the near future will have different results.
Some sectors are sounding the alarm
As Beijing and Shanghai begin to emerge from stifling COVID lockdowns, the southern economic hotbeds of Shenzhen and Macao could face crippling restrictions.
Shenzhen’s technology hub has locked down several neighborhoods and authorities are carrying out mass testing. Nearby, in the Asian gambling hub of Macau, a virus outbreak is threatening gambling companies operating in the city.
The Financial Times reported that total gaming revenue in Macau for the month of May was $413 million, a 90% drop from pre-pandemic levels.
SJM Holdings, the gaming giant founded by gambling magnate Stanley Ho, saw its stock and bond prices plummet as Fitch Ratings downgraded its senior unsecured credit rating two notches to BB- in June. Shares of other game companies such as Sands China Ltd. and Wynn Macau Ltd. have also fallen recently.
Of course, Chinese property developer bonds continued to trade well below par. But recently, there have also been signs of contagion that have spread beyond the usual sectors. For example, Chinese conglomerate Fosun International’s offshore bonds suffered heavy losses in June, a sign that other heavily indebted companies may also be struggling. Fosun, the owner of the Club Med resort, has subsidiaries in the leisure, travel and entertainment sectors and could burn cash if COVID-related lockdowns persist and consumer spending continues to decline.
Attract foreign investors
Beijing regulators hope a new program will help reverse recent trends in foreign fund flows.
The People’s Bank of China announced that qualified foreign institutional investors (QFII), including deep-pocketed foreign banks, sovereign wealth funds and pension funds, will be allowed to invest in the domestic foreign exchange market.
From June 30, China’s foreign exchange market will allow foreign institutional investors access to certain securities not available on the interbank market, including riskier instruments such as asset-backed securities and derivatives, in addition to obligations. It should be noted that the foreign exchange market is regulated by the China Securities Regulatory Commission (CSRC) while the interbank market (which QFIIs had access to since 2016) is supervised by the PBoC.
But will it work? Some intrepid fund managers with a penchant for distressed investing might jump at this opportunity. But for the mainstream, China’s COVID politics and dark clouds over its economy coupled with higher fixed income relative yields in the US, the Chinese market is simply not very attractive.
The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.