Foreign cash flees China as investors shun autocracies

Overseas money is starting to pull out of Chinese markets after the risk of investing in autocratic countries was starkly highlighted by sharp drops in Russia’s currency and securities prices following its invasion of Ukraine.

Market data shows foreign investors sold a net 38.4 billion yuan ($6.04 billion) of Chinese stocks and bonds in the January-March period, one of the highest such quarterly figures on record.

“Outflows from China on the scale and intensity we are seeing are unprecedented,” the Institute of International Finance said in a report published in late March. “Russia’s invasion of Ukraine may be pushing global markets to look at China in a new light.” It said the latest capital flight is “very unusual” as other emerging economies are not seeing similar outflows.

The value of trading by overseas investors in shares listed on the Shanghai Stock Exchange and the Shenzhen Stock Exchange can be estimated through transactions in the Stock Connect channel between mainland China and the Hong Kong Stock Exchange. The net inflow of foreign capital continued until February, but flipped to a net outflow of 45.1 billion yuan in March.

Meanwhile, the outstanding balance of Chinese bonds held by foreign investors shrank by 80.3 billion yuan in the month of February, the largest drop since January 2015 when comparable data became available.

Combined net selling of stocks and bonds in the first quarter topped outflows at the time of the “China Shock” of 2015 and the COVID-19 crisis in 2020.

The exodus marks a sharp contrast to the last few years, when investment in Chinese securities shot up as markets opened and stocks from the country were included in global benchmark indexes. The ratio of Chinese and Hong Kong stocks in major emerging market funds rose to just under 40% a few years ago from little more than 10% in 2008.

But that has since fallen back to 29% due to the triple whammy of the COVID-19 pandemic, tougher regulations on information technology and the Ukraine war. Capital that poured into China over the past three years may have begun to flow back out, said Sean Taylor of German asset manager DWS.

Investors are not simply adjusting positions for the short term, but reviewing their long-term strategy as they begin to pay closer attention to China’s political structure and value system — something many have largely ignored until now. “We are debating whether we should keep investing in China when concerns are mounting about a possible Chinese invasion of Taiwan,” said an official at a leading Japanese pension fund, an active investor in Chinese securities.

A resurgence in coronavirus cases in China, with Shanghai imposing strict lockdown measures, could fuel further flight of foreign investment from the country.

While capital continues to flee China, demand is increasing for exchange traded funds specializing in securities from liberal countries.

ETFs linked to the Freedom 100 Emerging Markets Index, which uses the degree of a nation’s political and economic freedom as key allocation metrics, logged its largest ever inflow in March at $53 million. Norway’s sovereign wealth fund, the world’s largest, has decided to remove leading Chinese sportswear company Li-Ning from its portfolio in the face of alleged human rights violations. The price of Li-Ning shares fell just over 10% last month.

Cooling appetite for Chinese securities is not new to U.S. investors, however, as a trend toward the “decoupling” of Sino-U.S. money became clear around 2016. Chinese acquisitions of U.S. real estate, entertainment and other businesses fell sharply after Beijing tightened its oversight of Chinese investment overseas. Washington, in turn, strengthened the power of the Committee on Foreign Investment, a body authorized to review overseas investment in the U.S. It also banned investment in certain Chinese companies, including those related to munitions.

More recently, the Tracker Fund of Hong Kong, one of Asia’s biggest ETFs, said in late March that it will switch its fund manager from State Street Global Advisors of the U.S. to Hang Seng Investment Management in Hong Kong. Local investors had criticized State Street’s plan to comply with U.S. sanctions, which ban investment in certain Chinese companies.

“Decoupling is a worst-case scenario,” said Wang Shengzu of Haitong International, a Hong Kong-based securities house. But Wang noted there could be a chance for “recoupling” in the future, given the scale of Chinese and Hong Kong markets and their relations with the U.S. and Europe.

The U.S. and China depend on each other, with their financial connections much deeper than with other countries. The balance of U.S. and Chinese investment in each other’s stocks and bonds reached $3.3 trillion at the end of 2020, according to U.S. consultancy Rhodium Group. Unraveling such close ties could have a serious impact on the world economy, said one financial expert.

Authors: TAKESHI KIHARA, AKIRA INUJIMA, NIKKEI Asia