Hello everyone and welcome back to another episode of the emerging market report. Today, I'm sitting here with my colleague, Alvin Tan to discuss China as an asset class and the rise of China as an asset class recently. Hello Alvin. Hi. Alvin, you have been receiving a lot of feedback recently about the Rise of China as an asset class, China financial market. What do you think is the main benefit for investors in thinking about China as an asset class now, now?
Global investors have indeed shown a growing interest in Chinese financial assets. For example, I think it's striking that foreign holdings of onshore Chinese bonds doubled in US dollar terms between the middle of 2018 and the end of 2020. And this happened in the midst of the growing geopolitical tensions between the US and China. This growing foreign interest grew out of a combination of the increased Chinese opening of the domestic financial markets to foreign investors, and also the latter's interest in Chinese assets. In the world low or negative interest rates. Institutional investors also find the liquidity in Chinese financial assets attractive compared to many other smaller emerging markets. Moreover, Chinese fixed income securities provide strong diversification benefits, given the low correlations to both developed market equities and bonds. And it is in this diversification potential that Chinese bonds could develop into a separate asset class from EM bonds.
The Chinese Renminbi is one of the best performing currencies in the last 12 months, despite COVID
19 and the economic slowdown. Clearly portfolio flows have been a factor for the recent performance. How do you think these will fare moving forward?
Yes, the growing interest in Chinese assets is a fundamental tailwind for the Renminbi, a topic which we have discussed previously. That said, there is also a growing concern among some Chinese policy makers of the dangers of large sustained foreign capital inflows on domestic financial stability. The lessons of the 1997 Asian financial crisis are still relevant in this regard. While Beijing has endorsed capital account liberalization, the capital account remains heavily restricted due to fears of a capital flight. This imbalance could become problematic, as capital inflows accelerate while outlets for domestic capital remain more limited. And outflow channels were in fact tightened in 2016 through 2017 when there was a surge of outflows. More recently, the scaling back of the Belton Road Initiative has curtailed another major capital outflow channel.
The interest from Beijing to increase Renminbi internationalization but keep a tight control of who is participating in local markets , seems contradictory. What direction do you think policy makers in China will take moving forward?
You are right. China faces troublesome contradictions between one, a growing openness to foreign participation in its financial markets, two, a desire for wider Renminbi internationalization, and three, its unwillingness to relinquish control of the capital account and the exchange rate. So, Beijing is trying to juggle these three balls in the air. At some point, a more decisive policy direction will need to be taken, but there doesn't appear to be a consensus on this point at this current time. So, the juggling will persist. In the interim, the growing capital inflows into China's financial markets will continue to exert upward pressure on the Renminbi, not least because the outflow channels remain limited, as mentioned. But, the authorities will also continue to lean against the speed of depreciation. So, further strength ahead but likely at a slower rate than what we saw last year.
Thank you Alvin, and thank you everyone listening.
Thank you.
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