Samuel Shen and Alun Johnson

SHANGHAI/HONG KONG, (Reuters) – While the plunge in China’s currency this month has brought back memories of previous routs, market participants claim that increased foreign holdings in yuan assets means authorities will be less likely to stop selling in comparison with years past.

On Friday, the yuan fell to an 18-month high and is now at 4.5% against the dollar for April. This puts it in its worst month since 1994’s currency market reforms.

Analysts and investors say foreign selling, which is now the predominant driver, presents new risks.

This, in combination with rising tailwinds favoring the U.S. dollars could result in further yuan weakness. The People’s Bank of China is unable or less inclined global capital movement restriction.

The presence of foreign money in China is even more important, as overseas investments on Chinese markets amount to just above 8 trillion Yuan ($1.2 Trillion) in the last year, compared to 1.5 Trillion in 2015. According the central bank,

“I don’t believe the renminbi’s weakening is because (authorities want to support exports,” stated Alicia Garcia Herrero of Natixis Asia Pacific chief economist, referring only to the currency’s official name.

She said that she believes the renminbi’s pressure comes from the departure of investors and the loss of economic confidence.

China’s foreign currency regulator stated last week that China’s economy was resilient and capital flows are reasonable. Yuan assets remain attractive for foreign investors.

Despite the PBOC reducing banks’ foreign currency reserve requirements for this week, the PBOC is still allowing yuan to fall. This was seen as a sign of support for the yuan.

China has loosened monetary policy in support of the economy during the worst local epidemic since COVID-19 emerged in Wuhan late in 2019. This is even though the U.S central bank increases rates to combat inflation.

Chinese stock markets fell 6% in April, while latest flows data revealed that foreigners drew $17.5 billion in local bonds and shares in March.

Yuan Yuwei (a manager of Water Wisdom Asset Management’s hedge fund) said, “What you see in the mirror is the yuan’s strength in 2020 when China had just recovered from the pandemic.”

Yuan explained that the policy of zero-COVID causes local governments’ fiscal condition to deteriorate, and businesses go under.

FOREIGN FLIGHT

The global banks have been quick to reduce their projections of 2022 yuan amid the slump.

Standard Chartered (OTC) believes that persistent capital outflows could drive the currency further down to 6.7 dollars by June’s end.

Capital flight has become a major driver of capital fleeing to foreign investors and not local ones. This makes capital control more challenging for regulators.

According to Reuters data and a poll, households don’t rush to purchase dollars. This gives foreign investors (8 trillion) in yuan stocks and bonds a greater role in trans-border flows.

Local investors, on the other hand, have concerns.

Jin Shengrong is the finance manager of Nanjing Golden Chemical Co and said, “I am more concerned about the effect from COVID than yuan.”

According to Xia Chun, many Chinese traveled to Hong Kong in 2015 to purchase insurance to move their money abroad. Xia Chun, chief economist of Yintech Investment Holdings, a Chinese wealth manager, stated that you can’t travel to Hong Kong as easily because COVID.

China must now “persuade global long-term money to stay.” They don’t always come back once these investors leave.

SWORDS FOR DAMOCLES

As global sentiment plummets, this could make it difficult.

According to COPLEY Fund Research, China’s weight in emerging markets portfolios is already falling. It fell from 38.3% at the peak in 2020 to 29% now, in large part due to Beijing’s crackdown on tech.

Steven Holden founder stated that, in the wake of Western sanctions against Russia “we believe that managers are revising the risks associated with holding such large amounts in China stocks,” because Beijing is friendly with Moscow.

Julius Baer (a Swiss wealth manager) stated that Chinese equities will be removed from core assets after a five-year period. This was based on Western sanction concerns.

Geopolitical risk is the “swords that Damocles (that), hang dangerously over China’s economy and capital markets,” said Yves Bonzon, chief investment officer Julius Baer Group.

China’s economy has been growing, and this month’s fall has only brought the Yuan back to its middle range since 2016.

Although the yuan is still very strong in trade weighted terms it’s most likely to struggle for a floor without central bank guidance.

Analysts at J.P. Morgan stated in a note that “the absence of dollar unloading over the last week is not due to corporates being short of dollars to buy, but rather because they have switched to a wait and see mode given the unanchoring FX expectations.”

CNY will be trapped by a negative feedback loop in which CNY’s expectations are worsening and corporate counter-cyclical dollar sales delay.

($1 = 6.6362 )