Strong yuan, not stock market, tops Xi’s wish list

Second order. When Xi Jinping outlined the core elements China should strive for as a “financial power” to a study session of Communist Party cadres this month, a strong currency topped his list. Other things he noted were a strong central bank and strong regulators. The leader did not mention the stock market. It offers a glimpse of Beijing’s priorities as foreign investors rush to dump their equity holdings.

China and Hong Kong were the worst performing major equity markets last year. Global long-only funds offloaded more than $3 billion in each of the last four months, per Morgan Stanley. The selloff has continued into 2024. After posting its biggest one-day drop since April 2022 on Monday, the benchmark Shanghai Composite is down 7.4% this month.

The foreign selling accelerates capital outflows and adds pressure to the yuan, which has weakened 4.5% against the U.S. dollar over the past year. Some economists expect the Chinese central bank will cut borrowing costs to boost the $18 trillion economy, yet aggressive monetary easing would increase the spread between U.S. 10-year Treasury bonds currently yielding 159 basis points more than their Chinese equivalents, and that could lead more capital being sucked out of the People’s Republic.

Beijing is prepared to stop some of the rot. Big Chinese lenders tightened liquidity in the offshore market while actively selling U.S. dollars onshore on Jan. 23, Reuters reported, to prevent the yuan from falling too fast as Chinese stocks plunged. On Monday, the State Council pledged to roll out more forceful measures to promote “the stable and healthy development capital market” and to bring in more long-term capital. According to Bloomberg, policymakers are mulling a 2 trillion yuan ($278 billion) fund for the rescue. This “stabilization fund” will mainly come from the offshore accounts of Chinese state firms to buy stocks onshore through a Hong Kong stock exchange connect scheme.

Fighting the fire onshore with offshore money involves converting Chinese firms’ dollar reserves into yuan, which will help support the Chinese currency, as well as provide relief to stocks. Currently, the weak equities market reflects widespread concern over the economy but there is usually no strong relationship between China’s economic growth and stock price performance. Ultimately, the stock market looks like a second order priority for officials.