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China freezes outbound investment quotas as outflows hurt yuan
China refrained from granting new quotas for residents to invest in overseas markets for a fifth month in August, the longest halt in six years, as authorities seek to stem weakness in the yuan.
The State Administration of Foreign Exchange, which has approved 132 local institutions to put as much as US$89.99 billion in offshore assets via its Qualified Domestic Institutional Investor program, hasn't granted new allocations since March. Quotas for overseas investors to access domestic capital markets rose US$16.4 billion to US$140.3 billion in the period, data from the regulator show. The yuan traded 1.8 per cent weaker outside of China than inside the country on Monday, indicating depreciation pressure.
China is trying to open its capital account enough for the yuan to win reserve status from the International Monetary Fund, while trying to curb an exodus of funds from an economy expanding at the slowest pace since 1990. Chinese investors are seeking to diversify in overseas assets after the Shanghai Composite Index of shares tumbled 40 per cent from this year's peak on June 12. The yuan has slumped 3.5 per cent in Shanghai and 5.2 per cent in Hong Kong in the past 12 months.
"Interest is there but whether the money can leave in the short term is the problem," said Thomas Kwan, Hong Kong-based chief investment officer at Harvest Global Investments Ltd., whose Chinese unit offers QDII funds. "To avoid triggering excessive yuan outflows, I don't think regulators would grant additional QDII quotas in the short term."
The State Administration of Foreign Exchange didn't reply to a faxed request for comment. China's QDII quota increased 8 per cent in the first quarter of this year, after falling 1 per cent in 2014 as the regulator withdrew some unused ones. That for Qualified Foreign Institutional Investors, allowing overseas companies to buy domestic securities with foreign currency, has expanded 15 per cent this year.
"Policy makers are not enthusiastic about granting more QDII quotas right now," said Chen Xingdong, chief China economist at BNP Paribas SA in Beijing. "The depreciation pressure has intensified. They don't want to do anything now that could strengthen capital outflows."
China's foreign-exchange reserves fell by a record US$93.9 billion last month to US$3.56 trillion, data from the central bank showed Monday. That was less than the median estimate of US$3.58 trillion in a Bloomberg survey. The stockpile has shrunk US$411 billion in the past year, after reaching a record US$3.99 trillion in June 2014.
Expectations that the US will raise rates for the first time since 2006 this year are also luring funds from China, which has been loosening monetary policy since November. The one-year Chinese government bond yield is 1.91 per centage points higher than that of US Treasuries, down from 3.69 a year ago.
"Interest to have US dollar exposure is much higher now because of worries on yuan depreciation," said Harvest's Kwan. Diversification is now a consideration as well as returns, he said, so clients are becoming interested in developed-market equities in addition to Hong Kong dollar-denominated Chinese shares and US currency bonds of Chinese companies.
By keeping borrowing costs low to counter the slowdown, seeking to prevent further currency depreciation with intervention and opening up the capital account, policy makers are challenging Nobel-winning economist Robert Mundell's "impossible trinity" principle. That theory stipulates a country can't maintain independent monetary policy, a fixed exchange rate and free capital borders all at the same time.
China's capital and financial account deficit was a record US$78.9 billion in the first quarter of this year. Vice Public Security Minister Meng Qingfeng said regulators will start a campaign to crack down on underground banks and illegal cross- border money transfers, according to an Aug 24 statement on the ministry's website.
On the home front, China is pressing ahead with easing capital controls. On July 15, it issued new rules requiring only registration instead of pre-approval for foreign central banks, sovereign wealth funds and global financial organizations to trade Chinese bonds. Regulators cleared six Renminbi QFIIs, four QFIIs and another three overseas institutions to trade on the interbank bond market, according to statements posted on the website of the National Interbank Funding Center on Monday. The RQFII program allows yuan raised offshore to be invested in Chinese domestic assets.
In the other direction, progress has stalled with no details on extending a stock exchange link between Shanghai and Hong Kong to include Shenzhen. It's reasonable to expect the QDII2 scheme, allowing domestic investors to buy overseas property or securities directly, to be delayed, Huang Li, a Shanghai-based analyst at Fitch Ratings, said last month. Outbound investment flows via QDII rose about 30 per cent following the stocks rout, she said, based on third-party data.
"By liberalizing offshore investment for mainlanders, there's a potential that if people onshore are genuinely lacking in confidence in local markets, then there's really no other place for you to park your money," said Aidan Yao, a Hong Kong- based senior economist at AXA Investment Managers, which oversaw the equivalent of US$773 billion at the end of June. "The issue is with investors looking offshore for investment opportunities at a time when confidence is not restored. You could risk larger outflows than otherwise."