China Allows More Investment Outflows to Ease Pressure on Yuan
China last year reported the first annual deficit on the financial account in its balance of payments in four years as regulators allowed more money to flow out of the country to ease appreciation pressure on the yuan stemming from rising foreign investment in the country’s capital markets.
The 2020 deficit, excluding reserve assets held by the central bank, amounted to $77.8 billion, although that’s down from an initial estimate of $175.9 billion given in February, according to revised figures for the balance of payments released by the State Administration of Foreign Exchange (SAFE) on Friday. It’s the first shortfall since 2016 when the country had a financial account deficit for the year, excluding reserve assets, of $416.1 billion. The financial account includes domestic ownership of foreign assets –– such as deposits, loans, securities, commodities and direct investment –– and foreign ownership of domestic assets.
“The deficit on the financial account excluding reserve assets shows that the accumulation of overseas assets by China’s private sector is continuing,” the administration said in a report (link in Chinese) accompanying the data. “First, domestic residents have increased their investment in overseas securities, which shows that demand to diversify assets (in investment portfolios) is strong. Second, outbound direct investment has been rational and orderly. Third, banks have increased their deposits and loans overseas, as the current account surplus has provided relatively abundant foreign currency liquidity.”
“Amid the continued appreciation of the yuan since June 2020, China’s foreign exchange policies have focused on increasing the flexibility of the exchange rate, expanding capital outflows and controlling capital inflows,” Guan Tao, chief global economist at BOC International (China) Co. Ltd. (601696.SH), wrote in a Feb. 23 report (link in Chinese) on the preliminary balance of payments data. He said he expected this foreign-exchange policy mix to continue as the “orderly expansion of capital outflows is an important policy tool to cope with the appreciation pressure on the yuan.”
The yuan appreciated 8.8% against the U.S. dollar in the second half of 2020, ending the year at 6.50 per dollar, up from 7.13 per dollar at the end of May.
Growing confidence in China’s recovery from the Covid-19 pandemic as other major economies continued to suffer, and higher yields on Chinese government bonds compared with U.S. Treasuries also contributed to an increase in inflows of foreign capital last year.
Outstanding overseas holdings of bonds traded in the onshore interbank market rose to 3.25 trillion yuan ($495 billion) at the end of December, a net increase of 1.1 trillion yuan from a year earlier, data from China Central Depository and Clearing Co. Ltd. and the Shanghai Clearing House show.
In an interview with Caixin, Guan said that foreign exchange in the onshore market was abundant in 2020, allowing banks to absorb domestic deposits in foreign currency and then deposit or lend them abroad.
The abundance of foreign currency liquidity, especially the U.S. dollar, led to a decrease in the cost of financing in foreign currency which led to an increase in domestic loans made in foreign currency, said Wang Youxin, a senior researcher at a research institute backed by Bank of China Ltd. (601988.SH).
Overall, China had a balance of payments surplus of $168.1 billion in 2020, comprising a current account surplus of $274 billion, and a combined capital and financial account deficit of $105.8 billion, the latest data show. That compares with $129.2 billion in 2019 and $177.4 billion in 2018, according to revised SAFE figures.
The financial account (金融账户) typically involves equity investment and debt financing, while the current account (经常账户) measures a country’s total trade in goods and services plus earnings on cross-border investments. Under the financial account, direct investment (直接投资) and portfolio investment (证券投资) had a surplus of $102.6 billion and $87.3 billion, respectively, while other investment (其他投资项) had a deficit of $256.2 billion, up 160% from 2019, the data show. Other investment includes all financial transactions not considered direct investment, portfolio investment, financial derivatives, employee stock options, or reserve assets.
In 2020, net outflows in other investment amounted to $314.2 billion, the highest since a deficit of $349.9 billion in 2016. This mainly comprised greater net outflow of deposits of $130.4 billion, 28% higher than in 2019, and a net jump in cross-border loans of $128.2 billion which reversed a net decline of $26 billion in 2019, as banks increased their overseas lending and companies added to their overseas deposits amid ample liquidity, according to the SAFE report.
Domestic deposits in foreign currency jumped by $131.6 billion in 2020, the largest increase since 2014, while loans in foreign currency grew by $80.2 billion, the most since 2013, according to data (link in Chinese) from the People’s Bank of China.
For portfolio investment, cross-border funds flowed actively into and out of the Chinese mainland in 2020, SAFE wrote in its report. Last year, domestic investors bought a net $167.3 billion of overseas stocks and other types of securities, while their overseas counterparts purchased a net $254.7 billion in the Chinese securities markets, both hitting a record high since the data series on international balance of payments began in 1982.
The significant increase in inflows was due to “overseas investors’ bullish outlook on China’s medium- and long-term economic development, China’s attractive bond yields under its prudent monetary policy, and the country’s high-level opening-up of its financial markets which has created a favorable environment for investors to adjust their cross-border portfolios,” SAFE said in its report.
Contact reporter Luo Meihan (firstname.lastname@example.org) and editor Nerys Avery (email@example.com)
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