Some foreign financial institutions have stated that China is currently on the verge of a vicious cycle reminiscent of Japan in the 1970s and 1980s, characterized by record-breaking debt leading to fire sales, debt repayment, monetary supply contraction, asset price declines, a wave of bankruptcies, soaring unemployment rates, economic slowdown, and a crisis of confidence, which in turn leads to currency hoarding and deflation, among other things.
Compared to Japan at that time, China is currently facing more severe real estate market debt, large financial institution defaults, skyrocketing youth unemployment, and a record decline in foreign direct investments.
Moreover, China is also facing the risk of a sudden increase in the scale of foreign exchange outflows. Goldman Sachs' favored foreign exchange flow indicators show that China's net foreign exchange outflows in July were about 26 billion US dollars, marking the fastest outflow since September 2022. Despite net stock purchases in both southbound and northbound Shanghai-Hong Kong Stock Connect in July, net inflow of funds through the Shanghai-Hong Kong stock connect was minimal, and factors such as the decline in the foreign exchange conversion rate in July goods trade and the widening of the service trade deficit dragged down the net outflow of cross-border RMB transfers for the month.
In July this year, the net outflow from direct spot transactions in China was 25 billion US dollars, while the inflow from new and cancelled forward transactions was 14 billion US dollars. Data from the State Administration of Foreign Exchange on RMB cross-border flows show an outflow of 16 billion US dollars in June. The State Administration of Foreign Exchange said that foreign investors continued to net buy RMB assets in July.
Data on Shanghai-Hong Kong Stock Connect fund flows show a net purchase of 7 billion US dollars of stocks through the northbound channel and a net purchase of 2 billion US dollars of stocks through the southbound channel, meaning a net inflow of funds through the Shanghai-Hong Kong Stock Connect was 5 billion US dollars, while the inflow in June was 3 billion US dollars. However, data on foreign investors holding RMB bonds has not yet been released.
Due to a decrease in capital inflows related to goods trade and an increase in capital outflows related to service trade, the fund flows in the current account were essentially balanced. Specifically, the net inflow of funds related to goods trade in July was 18 billion US dollars, far below June's 36 billion US dollars. Due to the continued depreciation of the RMB exchange rate, the surplus conversion rate for goods trade in July dropped from 50% in June to 22%. Meanwhile, as outbound tourism continued to recover, the service trade deficit was 11 billion US dollars, higher than June's 8 billion US dollars. However, the outflow from income and transfer accounts in July was 6 billion US dollars, lower than June's 8 billion US dollars.
On Tuesday this week, the People's Bank of China cut policy interest rates, increasing the pressure on the depreciation of the RMB. At present, although the People's Bank of China and monetary authorities may take more measures in the coming weeks to slow the depreciation trend of the RMB, such as counter-cyclical factors, reducing the foreign exchange deposit reserve requirement ratio, and increasing the foreign exchange forward sales reserve requirement ratio, etc. However, given the current economic growth dilemma China faces, the risk of major housing developers and some financial institutions, supporting weak economic growth momentum, and improving the medium- and long-term economic outlook remain the primary tasks of the People's Bank of China and monetary policy authorities.
With the RMB at its weakest level ever and a rapid acceleration of foreign exchange outflows, one cannot help but recall the panic following the RMB devaluation in August 2015. That devaluation not only shocked global markets but also awakened electronic currencies from their long-term slumber.
