Is China still a good investment in the midst of Covid and Russia’s war?

China had a portfolio of $ 17.5 billion outflows last month, an all-time high, according to the latest data from the Institute of International Finance (IIF). The US-based trade association called this capital flight of foreign investors “unique”, especially since there were no similar outflows from other emerging markets during this period. The outflows included $ 11.2 billion in bonds, with the remainder being equities.

Data from the Chinese government also showed a record decline in the bond market of foreign investors in recent months. Foreign investors loaded off a net 35 billion yuan ($ 5.5 billion) of Chinese government bonds in February. largest monthly reduction ever, according to China Central Depository and Clearing. Sales accelerated in March, reaching a new high of 52 billion yuan ($ 8.1[ads1] billion).

“China’s support for the Russian invasion of Ukraine was clearly the catalyst for capital to leave China,” said George Magnus, an associate at the China Center at Oxford University and former chief economist at UBS.

China and Russia proclaimed in February that their friendship had “no borders.” That was before Russia invaded Ukraine. Now, with Russia’s economy plagued by sanctions from around the world, Beijing has not rushed to help its northern neighbor, fearing it could also be caught up in sanctions. But it has also refused to condemn Russia’s attack on Ukraine, trying to portray itself as a neutral player and blame the situation on the United States.

“There is nervousness about China’s ambiguous but Russia-prone attitude to the Ukraine conflict, which raises concerns that China could be sanctioned if it helps Russia,” said Martin Chorzempa, a senior fellow at the Peterson Institute for International Economics. China’s economy and US – China relations.

The war in Ukraine has also raised concerns about the risk that China could increase its military might against Taiwan, triggering a massive capital flight from the Asian island.

But geopolitical tension is not the only reason behind the emigration. Rising interest rates in the US and China’s severe Covid-related cuts have also played a role in intimidating investors.

The US Federal Reserve is raising interest rates for the first time since 2018 to curb inflation, while the People’s Bank of China has entered a relief cycle to strengthen its faltering economy. This means that China looks less attractive to investors compared to the United States. Earlier this month, interest rates on China’s 10-year government bond fell below US government interest rates for the first time in 12 years. And the yuan hit a six-month low against the US dollar.

“The rise in interest rates, especially in the United States, makes the nominal return associated with Chinese interest – bearing assets less attractive on a relative basis,” Chorzempa said.

Furthermore, Beijing’s unwavering commitment to its zero Covid policy has taken a massive economic toll, increasing uncertainty about future growth.

“The economy is weakening and is being exacerbated by government action and by zero Covid policies,” Magnus said.

China’s economy slowed sharply in March – consumption fell for the first time in more than a year, while unemployment in 31 major cities rose to record highs – as escalating Covid barriers in Shanghai and other major cities severely hit growth and supply chains.
Some economists are even talking about the possibility of a recession this quarter, as Beijing appears to be sticking to its zero Covid policy despite the high price.
A number of investment banks have cut their forecasts for China’s year-on-year growth over the past week. The International Monetary Fund on Tuesday cut its growth forecast for China to 4.4%, down from 4.8%, citing the risk from Beijing’s strict zero Covid policy. This is well below China’s official forecast of around 5.5%.

Confusion about the future

With these concerns growing, some fund managers and analysts have begun to question whether they should invest in China at all.

“China is seeing deep foreign capital flows as doubts increase about its basic investability,” said Brock Silvers, CEO of Kaiyuan Capital, a Shanghai-based private equity investment firm.

The pandemic is not the only reason behind China’s decline. Much of the country’s current economic pain can be traced back to the extensive regulatory work against the private sector, which was unleashed by President Xi Jinping in 2020. There are fears that the government will continue to crack down on sectors ranging from education to technology. year.

“Global investors do not want to play regulatory guessing games or worry that tomorrow’s news may drain another otherwise attractive company or business model,” Silvers said.

The speed and violence with which the authorities have acted against private companies has frightened even the closest China monitors.

China's largest private companies are in chaos.  It's all part of Beijing's plan
A set of rules unveiled in July last year essentially shut down the $ 120 billion private mentoring industry, putting tens of thousands of businesses out of business. Another decision by regulators to ban Didi – the country’s largest tour app – days after the US listing overwhelmed international investors and cost them dearly. The move resulted in a sharp sale of Chinese shares worldwide.

The Nasdaq Golden Dragon Index, a popular index that tracks more than 90 U.S. listed Chinese companies, lost 31% in the third quarter of 2021, the worst quarter ever. It then fell another 14% in the last quarter of last year. In comparison, the S&P 500 rose by 0.2% and 11% respectively in the third and fourth quarters of last year. The Nasdaq Composite also rose 8% in the last quarter of 2021.

Some of the money flowing out of China may have gone into US dollars, while there is also “a remarkable transition from China to India,” according to Qi Wang, chief investment officer of MegaTrust Investment in Hong Kong.

Shrinking appetite

The impact on the private sector has also affected private equity funds that focus on China.

Funds raising US dollars to invest in China attracted just $ 1.4 billion in the first quarter of 2022, down 70% from the previous quarter, according to Preqin, a London-based investment data company.

A separate study from Bain & Company showed that Greater China-focused private equity funds attracted $ 28 billion in new funding for the second half of last year, down 54% from the first half of the year, as global investors are increasingly concerned about political and economic uncertainty in the Chinese market.

Looking ahead, about 55% of respondents expect [fundraising] the situation will become more challenging over the next 12 months, “said Kai Zhong, a leader in the China Private Equity team at Bain & Company.

On the fence

But while bond and equity funds may reduce exposure to China, there is evidence that global companies continue to invest in Chinese companies.

Foreign direct investment in China reached record highs $ 173 billion in 2021, up 20% from the previous year, according to data from China’s Ministry of Commerce.

Chorzempa noted that the FDI record came even though “regulatory uncertainty and a darker view among decision-makers outside China were already very prominent.”

“So it is not clear whether the data from the last two months represent a paradigm shift or more of a temporary recalibration to a still very strong investment relationship, especially with Europe,” he said.

According to an annual survey conducted by the European Union Chamber of Commerce in China last year, only 9% of the nearly 600 European companies operating in China planned to move any current or planned investment out of China, the lowest percentage ever.

Nevertheless, there are signs that some of them have become anxious about China’s zero Covid policy.

Covid blockades cause chaos in the world's largest car market

Earlier this week, Chinese Trade Minister Wang Wentao met with a few foreign chambers to discuss the impact of the country’s zero Covid policy.

Jens Hildebrandt, CEO of the German Chamber of Commerce in northern China, told CNN Business that the participants raised some Urgent problems Member companies face related to the Covid restriction strategy, especially in Shanghai.

An ongoing shutdown in Shanghai – a major business and manufacturing center – has forced most businesses to shut down for several weeks, threatening to disrupt key car and electronics supply chains. It has also exacerbated port delays and forced the halting of many passenger flights, which has sent air freight rates into the air and put even more pressure on global supply chains.

“The current policy of shutdowns leading to production shutdowns, logistics and supply chain disruptions and restrictions on human movement is not only a short-term concern, but will leave its mark in the long term,” Hildebrandt said in an email to CNN Business.

“As foreign companies are suffering financially, we are looking for clear signals about how the Chinese government will help ease the burden through aid programs,” he added.

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