Geopolitical risks and COVID blockade force outflows of Chinese capital

China's capital has suffered the largest first quarter decline in its history. These portfolio outflows, mainly represented in local currency bonds, are due to COVID-19 blockages, depreciation and the perceived risk of investing in countries with unstable relations with the West.

According to the Institute of International Finance (IIF), this loss of capital is due to the sale by various shareholders who sold shares and bonds, the latter in local currency. External bond sales began in February and accelerated during March.  To these sales must be added the outflow of a portion of Russia's reserves of approximately 70 billion dollars to China, which is one of the movements that have caused the Asian country to lose the most capital. "China's portfolio outflows reached unprecedented proportions in the first quarter. Overall, they are unlikely to cause notable external financing problems," the IIF announced, but without giving an exact figure. They added: "Russian reserve sales may explain some of the outflows at the start of the [Ukraine] war, but we are not convinced that they are driving this episode," as reported by The National News. 
 

The geopolitical tensions caused by Russia's invasion of Ukraine, coupled with the difficulty of knowing which side China supports, have created uncertainty and commercial risks, and as a result, a large number of investors have fled the country. This situation has led to a historic flight of capital from China, which recorded losses of $17.5 billion in the last month. The outflows are divided between bonds, which accounted for an outflow of $11.2 billion, and equities valued at $6.3 billion. "Russia may have used RMB assets in the second half of February, when total reserves declined and access to dollar and euro assets became difficult," the IIF reported, adding: "It is less clear that in March Russia's sales were large as reserves remained stable. In any case, part of the current account surplus may have ended up in Chinese bonds, which are free of sanctions".

The losses in the first quarter of the year represent a reversal from 2020 and 2021, when China increased its investments by 30-40 per cent per year. However, this capital flight is not, according to the IIF report, a problem for external security, as China was expected to maintain its trade surplus at high levels after surpassing $200bn during the first quarter on its seasonally adjusted basis. "We take the outflows from China as a sign that investors are becoming more cautious about geopolitics, a development that may favour flows to EMs with smooth G7 relations," the IIF said.

The effects of the Ukraine invasion have not had as dramatic an impact on portfolio flows as first expected. According to the report so far the effects have not been "as catastrophic" as anticipated, however, outflows from emerging markets, which excludes China, have already been felt in outflows during the first quarter of the year.