Cross-Border Capital Inflows Return; RMB Expected to Rise Steadily

On October 22nd, the State Administration of Foreign Exchange (SAFE) released data on the balance of payments for the first three quarters of 2024 and held a press conference at the State Council Information Office. The data indicated that, due to the continued net inflow of goods trade and the gradual improvement of foreign investment in China, cross-border capital inflow was restored in the first three quarters of this year.

Currently, major global economies are facing adjustments in monetary policy, and there is still market divergence over the pace and path of future interest rate cuts by the Federal Reserve. The impact on China's foreign exchange market is a matter of great concern.

Xie Yaxuan, Deputy Director of the Research and Development Center at China Merchants Securities, told Yicai Global that in the fourth quarter, China faces the pressure of a phased outflow of cross-border capital. However, with the implementation of multiple policies such as "924" and "926", domestic economic expectations have significantly improved. Looking at a longer term, as the fundamentals of China's economy recover, the renminbi exchange rate will gradually strengthen, which is very important for improving the situation of international capital flows.

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Zhao Qingming, Deputy Dean of the Research Institute of Exchange Control Information Technology, told Yicai Global that from the perspective of the international foreign exchange market, the US dollar index is still relatively overvalued at present and will return to a balanced exchange rate range in the future. Coupled with the improvement of China's economic fundamentals, the renminbi exchange rate will strengthen steadily in the future.

Li Hongyan, Deputy Director of the State Administration of Foreign Exchange, stated at the press conference that the foreign exchange management department will continue to monitor and assess the international economic and financial situation and the monetary policy trends of major developed economies. They will continuously accumulate and summarize experience in dealing with these issues, enrich the policy toolkit, and carry out counter-cyclical macro-prudential adjustments in a timely manner to maintain the stable operation of the foreign exchange market.

Cross-border capital inflow was restored in the first three quarters of 2024. The data shows that in the first three quarters, measured in US dollars, the bank's customer-related foreign exchange receipts and payments had a surplus of 2.8 billion US dollars, with a small surplus in the first quarter, a shift to a deficit in the second quarter, and a return to a surplus in the third quarter. The main components included the continued net inflow of goods trade, the gradual improvement of foreign investment in China, and the overall orderly external investment by domestic entities.

Looking at the bank's foreign exchange settlement and sale data, the balance has basically been restored. In the first three quarters, the overall settlement and sale showed a deficit, mainly due to the expansion of the deficit in the second quarter; in the third quarter, it returned to a balanced level, with a surplus restored in September, with an increase in settlement and basically stable sales.

Xie Yaxuan told Yicai Global that an important factor affecting cross-border capital flows is the narrowing of the China-US interest rate differential, especially in the third quarter of this year, when the Federal Reserve unexpectedly cut interest rates by 50 basis points, and there is an expectation of further rate cuts, some cross-border capital sensitive to the interest rate differential has returned. On the other hand, after the Federal Reserve's rate cut, the US dollar index fell back, and the appreciation expectation of the renminbi has contributed to the return of some receivables, which has contributed to the capital return.

Zhao Qingming told Yicai Global that the main reasons for the expansion of the surplus in the third quarter are, first, the renminbi exchange rate has shifted from depreciation to appreciation, which has led to an increase in corporate settlement; second, the increase in the allocation of renminbi bonds by foreign financial institutions, as well as the increase in foreign capital inflows under the stock connection at the end of September.Data indicates that recently, the rate of settlement has been rising in an orderly manner, while the rate of sale has remained stable with a slight decline, and corporate willingness to settle and sell foreign exchange has remained rational. In the first three quarters, the foreign exchange income settlement rate, which measures the willingness to settle, was 62.1%, and the foreign exchange expenditure sale rate, which measures the willingness to purchase, was 68.9%.

At the same time, over the past period, the allocation of foreign capital to RMB assets has shown a generally positive trend. As of now, the total amount of RMB bonds held by foreign capital within the territory exceeds 640 billion US dollars, which is at a historical high. In addition, driven by the rise in the domestic stock market, since late September, the net purchase of domestic stocks by foreign capital has generally increased, further strengthening the willingness of foreign capital to allocate RMB assets.

At the same time, China's foreign exchange reserve scale has remained basically stable. As of the end of September, the balance of foreign exchange reserves was 3,316.4 billion US dollars, an increase of 78.4 billion US dollars compared to the end of 2023.

The RMB is expected to be stable with a slight rise.

At present, China's policy interest rate is also being reduced, and market interest rates represented by the ten-year government bond rate have entered a period of fluctuation; entering the fourth quarter, the Federal Reserve's interest rate reduction has slowed down, and the level of US Treasury bond rates has rebounded somewhat, and there is a trend for the China-US interest rate differential to further expand. What impact does this have on the trend of cross-border capital flows?

"On the surface, the factors affecting cross-border capital flows are the China-US interest rate differential represented by the ten-year government bonds of China and the United States, as well as the expectations of the RMB exchange rate, but behind it, it reflects the differences in the fundamentals of the Chinese and US economies," Xie Yaxuan said to the reporter.

In his view, in the fourth quarter, China will face the pressure of periodic outflow of cross-border funds, but at the same time, with the implementation of many policies such as "924" and "926", the domestic economic expectations have significantly improved. Both domestic asset prices and expectations for further bottoming out of the economy in the future have rebounded, which will offset the impact of the further widening of the China-US interest rate differential. Looking at a longer period, with the repair of China's economic fundamentals, the RMB exchange rate will be stable with a slight rise, which is very important for improving the situation of international capital flows.

"Objectively speaking, with the opening of the capital and financial accounts, the impact of cross-border capital flows on the RMB exchange rate and the resulting fluctuations have increased, but the exchange rate is largely determined by the economic fundamentals. Based on the judgment of the stable and good domestic economy and the judgment that the United States has entered the interest rate reduction cycle, the long-term decline of the US dollar index will be a trend, and the RMB will be stable with a slight rise against the US dollar in the medium term," Xie Yaxuan said to the First Financial reporter.

Looking at the changes in the exchange rate, since the beginning of this year, the spot exchange rate of the RMB against the US dollar within the territory has generally depreciated by about 0.3%, and the RMB exchange rate has remained basically stable in two-way fluctuations.

In addition to the factors of economic fundamentals, Zhao Qingming believes that from the perspective of the international foreign exchange market, the US dollar index is currently at 103, 104, and from the history of the past 20 years, it is still in a relatively overvalued state, and it will return to the equilibrium exchange rate range in the future, and non-US currencies should strengthen. Coupled with the improvement of China's economic fundamentals, the RMB exchange rate should be stable and somewhat stronger in the future.At the press conference held by the State Council Information Office on October 22, Li Hongyan stated that the exchange rate of the Chinese yuan is primarily determined by the market. Under the market-oriented formation mechanism, it is normal for the yuan to appreciate and depreciate, exhibiting two-way fluctuations.

The proportion of foreign debt in yuan and long-term foreign debt increases

A noteworthy figure is the overall growth of China's foreign debt scale in the first half of the year. As of the end of June, the foreign debt balance was $2.54 trillion, an increase of $97.1 billion from the end of 2023, representing a 4% increase.

Jia Ning, Director of the Balance of Payments Department of the State Administration of Foreign Exchange, said at the press conference that China's foreign debt is divided into two categories. The first category is the external debt formed by enterprises, banks, and other departments financing from abroad, which is an objective result of fully utilizing both domestic and international markets and resources, and is directly related to the development of cross-border trade and investment. The second category is the external debt formed by foreign capital purchasing domestic bonds, reflecting the global investors' demand for allocation of yuan assets. In recent years, with the increasing attractiveness of the yuan to foreign entities, the second category has become the main channel for the growth of China's foreign debt.

"As the cross-border operations of enterprises increase, the number of orders and projects from overseas has significantly increased. From the perspective of matching projects and funds, the increase in overseas financing is inevitable," Zhao Qingming explained to the First Financial Daily reporter.

"Obviously, the less debt, the better is not true; utilizing foreign capital can bring advanced markets, technology, and experience to our country. Of course, more debt is not necessarily better either," Xie Yaxuan told the reporter. The risk of foreign debt is usually measured by comparing the scale of foreign debt with a series of indicators that signify the state of the real economy, such as GDP and foreign exchange reserves. As China's GDP is expected to grow annually, theoretically, the scale of foreign debt should also maintain a certain growth. However, it is necessary to guard against a rapid increase in foreign debt that deviates from the fundamentals of the economy or a rapid rise in short-term foreign debt.

"The risk of foreign debt is controllable. The most important indicator is that the scale of foreign debt maturing within one year compared to foreign exchange reserves is far within the safety line," Zhao Qingming said to the reporter.

Jia Ning stated that in recent years, despite facing the significant easing and tightening of the Federal Reserve's monetary policy and changes in external financial conditions, China's foreign debt scale has remained generally stable, with the ratio to Gross Domestic Product fluctuating slightly within the 14% to 16% range. Cross-border financing by enterprises has effectively supported the development of the real economy. Secondly, the debt ratio, debt service ratio, debt ratio, and the ratio of short-term foreign debt to foreign exchange reserves are all within the internationally recognized safety line. In addition, the structure of China's foreign debt continues to optimize, which is reflected in the significant increase in the proportion of yuan foreign debt and long-term foreign debt. The risks of debt maturity mismatch and currency mismatch are controllable and have been significantly reduced.

Looking ahead, China's foreign debt is expected to maintain a stable development trend. As China's economy recovers and improves, the steady advancement of financial market opening and the continuous manifestation of the yuan asset allocation function will keep foreign investment in yuan bonds growing. At the same time, the potential for China's foreign trade and investment will continue to be released, coupled with the reduction in external financing costs driven by interest rate cuts in developed economies such as the United States and Europe, the demand for foreign debt by enterprises and other departments will gradually rise.