Investors are ditching China at an unprecedented scale

Investors are fleeing China in record numbers as a combination of political and corporate dangers, as well as rising interest rates overseas, make the world’s second-largest economy a less appealing place to park their cash. According to the most recent data from the Institute of International Finance, China had $17.5 billion in portfolio outflows last month, an all-time record (IIF). This loss of cash by foreign investors was described as “unprecedented” by a US-based trade organization, especially given the lack of similar outflows from other emerging countries over the same time period. Bonds accounted for $11.2 billion of the withdrawals, while equities accounted for the rest.

According to Chinese official data, foreign investors have been retreating from the bond market at an all-time high in recent months. According to China Central Depository and Clearing, foreign investors sold a net 35 billion yuan ($5.5 billion) of Chinese government bonds in February, the greatest monthly drop on record. In March, the sell-off picked up speed, reaching a record high of 52 billion yuan ($8.1 billion).

“China’s support for the Russian invasion of Ukraine was clearly the catalyst for capital to leave China,” said George Magnus to CNN, Magnus is a former top economist at UBS and an associate at Oxford University’s China Centre.

In February, China and Russia declared that their alliance had “no bounds.” That was prior to Russia’s invasion of Ukraine. Now that Russia’s economy is being hammered by international sanctions, Beijing has been hesitant to assist its northern neighbor, fearful that it, too, may be hit by sanctions. However, it has declined to denounce Russia’s aggression on Ukraine, preferring to portray itself as a neutral observer and blame the situation on the US.

The conflict in Ukraine has heightened fears that China may beef up its military power against Taiwan, causing a major exodus of capital from the Asian island. However, geopolitical tensions are not the main cause of the departure. The United States rate hike, as well as China’s severe Covid-related lockdowns, have frightened investors. To combat inflation, the US Federal Reserve is raising interest rates for the first time since 2018, while China’s People’s Bank has launched an easing cycle to support its faltering economy. As a result, as compared to the United States, China appears to be less appealing to investors. Earlier this month, China’s 10-year government bond yields went below US Treasury levels for the first time in 12 years.

Furthermore, Beijing’s steadfast commitment to its zero Covid policy has wreaked havoc on the economy and raised doubts about future growth prospects. As growing Covid lockdowns in Shanghai and other large cities significantly harmed growth and supply chains, China’s economy slowed sharply in March, with consumption falling for the first time in more than a year and unemployment in 31 major cities reaching a record high. Some economists are even predicting a recession this quarter, as Beijing appears adamant about maintaining its zero Covid policy despite the high cost.

In the last week, a number of investment banks have lowered their full-year growth projections for China. The International Monetary Fund dropped China’s growth prediction to 4.4 percent on Tuesday, down from 4.8 percent, citing dangers posed by Beijing’s tough zero-covid policy. This is significantly lower than China’s official prediction of 5.5 percent.

As these concerns grow, some fund managers and experts are beginning to wonder if they should invest in China at all. China’s slowdown is due to more than just the virus. President Xi Jinping’s extensive regulatory crackdown on the private sector, which began in 2020, is responsible for much of the country’s current economic suffering. This year, there are concerns that the government would continue to tighten its grip over areas ranging from education to technology. “China is experiencing significant outflows of foreign capital as concerns about the country’s fundamental investability grow,” said Brock Silvers, managing director of Kaiyuan Capital, a Shanghai-based private equity investment firm.

China’s slowdown is due to more than just the virus. President Xi Jinping’s extensive regulatory crackdown on the private sector, which began in 2020, is responsible for much of the country’s current economic suffering. This year, there are concerns that the government would continue to tighten its grip over areas ranging from education to technology. “Global investors don’t want to play regulatory guessing games or be concerned that tomorrow’s news could deplete another otherwise appealing company or business model,” Silvers explained. Even the most ardent China observers have been taken aback by the speed and intensity with which authorities have acted against private industry.

Last July, a series of laws was announced that effectively shut down the $120 billion private tutoring market, putting thousands of businesses out of business. Another move by regulators to prohibit Didi — the country’s most popular ride-hailing app — just days after its IPO in the United States startled overseas investors and cost them a lot of money. The crackdown triggered a massive sell-off in Chinese stocks around the world. In the third quarter of 2021, the Nasdaq Golden Dragon index, which covers more than 90 US-listed Chinese companies, lost 31%, the lowest quarter on record. In the fourth quarter of last year, it dropped another 14%. In the third and fourth quarters of last year, the S&P 500 gained 0.2 percent and 11%, respectively.

According to Qi Wang, chief investment officer for MegaTrust Investment in Hong Kong, some of the money moving out of China may have gone into US dollar assets, while there has also been “a considerable move from China to India.” Private equity funds with a concentration on China have been damaged by the government’s crackdown on the private sector. According to Preqin, a London-based investment analytics firm, funds raising US dollars to invest in China only attracted $1.4 billion in the first quarter of 2022, down 70% from the previous quarter.

According to a separate survey conducted by Bain & Company, Greater China-focused private equity funds received $28 billion in new funding in the second half of last year, down 54% from the first half, as global investors become increasingly concerned about political and economic uncertainty in China.

While bond and equity funds may be reducing their exposure to China, data suggests that multinational corporations are continuing to invest in Chinese enterprises. According to figures from China’s Ministry of Commerce, foreign direct investment inflows to the country reached a new high of $173 billion in 2021, up 20% from the previous year. Even if “regulatory uncertainty and a gloomy attitude among policymakers outside of China were already very prominent,” according to Chorzempa, record FDI flowed in.
“As a result, it’s unclear if the data from the previous two months signals a paradigm change or only a temporary recalibration of a still very strong investment relationship, particularly with Europe,” he added.

China’s trade minister, Wang Wentao, met with a few foreign chambers earlier this week to discuss the country’s zero Covid policy. The participants, according to Jens Hildebrandt, executive director of the German Chamber of Commerce in North China, emphasized certain significant difficulties that member firms are facing relating to the Covid-containment plan, particularly in Shanghai.

The protracted lockdown in Shanghai, a major commercial and industrial hub, has forced most enterprises to close for weeks, threatening to disrupt critical car and electronics supply chains. It has also exacerbated port delays and prompted the cancellation of a number of passenger flights, driving up air freight charges and placing even more strain on global supply systems.