Weaker Inflows Drive BOP Deficits

Global macro forces and domestic policy concerns shaped some uncharacteristic movement in China’s balance of payments in Q2 and Q3, particularly in the financial account. Overall, detailed Q2 and preliminary Q3 data imply foreign investors have gained a new appetite for Chinese bonds, but are less incentivized to contribute inbound direct investment or equity investment than in the past. Though currency and BOP pressures eased in Q2, they’ve strengthened since Q3, making changes in short-term exchange rate and reserves management more
urgent, while shortcomings in domestic market-oriented reform efforts present obstacles to restoring strong capital inflows.

Back to huge financial account deficit in 3Q: After a period of calm in Q2, the capital and financial account balance has moved back into strongly negative territory at -$207.3 billion according to preliminary Q3 data, with a $136.3 billion decline in foreign exchange reserves.

China’s FDI balance continues to worsen: Foreign direct investment outflows continued to be elevated in Q2 and Q3 but were in line with previous quarters; inflows through the FDI channel nose-dived, reaching a 10-year low, reflecting both shorter term factors but
also a more fundamental change in foreign investor sentiment.

Portfolio and other investment: China’s portfolio securities balance shifted to a net inflow ($7.8 billion) in Q2 for first time since 2014 due to a rise in yield-seeking foreign investment into Chinese foreign currency-denominated bonds, but these flows remain too marginal to shape the overall financial account deficit. Other investment flows shrunk considerably and external deleveraging stopped in Q2, but are expected to return to strong outflows in Q3 in light of recent currency depreciation.

Posted August 1, 2017
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