Could China Attract Higher Inflows after Bond Market Reforms?

Further, the CNY has been relatively stable compared to other emerging markets currencies because it is managed against a trade-weighted currency basket, and could therefore play a stabilizing force within the index. Concerns of CNY depreciation have kept foreign investor interest restrained over the last two years, and although further weakness is possible it is worth noting that inflows from potential index inclusion will help to at least partially offset current outflows that have put pressure on the currency’s value. On the other hand, increased two-way flows could also result in higher volatility depending on future market conditions.

The yuan remains a focus of attention of the international community and a key risk for China’s macroeconomic stability in recent years. In 2016, the Chinese yuan recorded its biggest fall since 1994, while depreciating for the third year in a row. China (EMLC) (EMAG) (IGEM) (PCY) has seen its foreign exchange reserves dwindle for the last couple of years due to unabated outflows. As a result, Chinese foreign exchange reserves shrank about 24.0% from ~$4.0 trillion in June 2014 to ~$3.0 trillion as of April 2017.

In order to support the yuan and arrest a fall in its foreign exchange reserve, China (LEMB) has imposed stricter rules on capital outflows in recent months. The attempt to control the movement of capital outside the country met with success, with foreign exchange reserves rising $21.0 billion in April 2017, the third consecutive month of increase. That was the first time since reaching its peak in June 2014 that reserves increased for three consecutive months. According to SAFE (State Administration of Foreign Exchange), the rise in foreign exchange reserves from February 2017 to April 2017 was due to the balance of capital flows and the appreciation of the yuan.

Although the yuan is expected to depreciate this year, the movement could be a controlled because authorities may want to create a stable environment in order to attract foreign capital. In recent weeks, we’ve seen that the yuan’s performance against the dollar is more stable than its movement in 2016. Additional inflows due to the opening up of China’s onshore bond (EMLC) (VWOB) market would further provide stability to the yuan.