China's Declining Influence: A $188 Billion Capital Exodus from World Markets

17 Sep, 2023

China's Declining Influence: A $188 Billion Capital Exodus from World Markets

The substantial withdrawal of capital from Chinese stocks and bonds is significantly reducing China's influence in global investment portfolios and hastening its separation from the rest of the world's financial markets. Foreign ownership of Chinese equities and debt has plummeted by approximately 1.37 trillion yuan ($188 billion) or 17% from its peak in December 2021 through the end of June this year, as per calculations based on the latest central bank data by Bloomberg. This trend has persisted even as onshore shares experienced a record outflow of $12 billion in August alone.

This capital flight aligns with China's economic challenges stemming from years of COVID-19 restrictions, a property market crisis, and ongoing tensions with Western nations. Such concerns have led to the "avoid China" sentiment becoming a prevalent theme among investors, as highlighted in Bank of America's recent survey. Additionally, foreign participation in the Hong Kong stock market has declined by more than a third since the close of 2020.

This year, China's economic struggles have not had the anticipated ripple effect on global markets, particularly emerging markets. While the MSCI China Index has fallen approximately 7% in 2023, marking the longest losing streak in over two decades, the broader MSCI Emerging Markets Index has risen by 3%. Investors have sought returns in alternative markets like India and parts of Latin America, distancing themselves from China.

China's efforts to achieve supply chain self-sufficiency and strained relations with the United States have made global markets less susceptible to economic fluctuations. Additionally, the artificial intelligence boom has favored markets in the US and Taiwan, offering less support to mainland Chinese shares. As a result, China's weight in the Emerging Markets Index has dwindled to around 27% from over 30% at the end of 2021.

Furthermore, there is a growing trend of excluding China from emerging-market portfolios, with the launch of equity funds that exclude China reaching a record high in 2023. This shift reflects concerns over various risks, including local government financing vehicles (LGFV), a housing market surplus, demographic challenges, regulatory uncertainties, and geopolitical tensions.

In the debt market, global investors have withdrawn roughly $26 billion from Chinese government bonds in 2023 while investing a collective $62 billion in bonds from other emerging Asian markets. Approximately half of the inflow ($250 billion-$300 billion) that accompanied China's inclusion in government bond indexes since 2019 has been erased, according to JPMorgan Chase & Co.

The selling pressure on the yuan, resulting in a 16-year low against the dollar, has been exacerbated by the central bank's loose policy stance. This stands in contrast to the tightening policies in most major economies, providing foreign investors with an additional reason to avoid local Chinese assets.

Regarding corporate debt, China appears to have fully decoupled from the rest of Asia, especially as the real estate crisis continues into its fourth year. The market is now predominantly held by domestic investors, with approximately 85-90% ownership.

Despite these challenges, China's enormous economy and its role in the global manufacturing supply chain ensure it remains a crucial component of many investment portfolios, albeit to a lesser extent. China can still exert influence on international financial markets through globally traded commodities, as it is the largest importer of energy, metals, and food. Its leadership in clean energy technologies, such as solar panels and electric vehicles, also positions it for trade opportunities as the world pursues climate obligations.

In conclusion, while China's economic difficulties and shifting dynamics have led to a decrease in its prominence in global markets, its sheer size and importance in various sectors ensure that it remains a complex and multifaceted investment landscape for global investors. This requires a nuanced approach, balancing caution with the identification of unique opportunities within China's evolving market.