China’s orthodox monetary policy continues to be in stark contrast to the G7 world.

It has also continued to attract inflows into its bond market though inflows have slowed in the short term given the narrowing of the spread between the Chinese 10-year and the US Treasury 10-year.

The spread between the Chinese 10-year government bond yield and the US 10-year Treasury bond yield has declined 105bp from a recent high of 252bp in mid-November to 147bp, while the Chinese 10-year yield is down 26bp to 3.09% over the same period.

China 10-year government bond yield and spread over US 10-year Treasury bond yield

Source: Bloomberg

Still this inflow is a long-term trend, as is ongoing flows into Chinese equities.


The surge in portfolio inflows into China of late has been the consequence of the undoubted success of both the Bond and Stock Connects in Hong Kong.

Foreign holdings of Chinese bonds have increased by Rmb361bn or 11% in the first four months of this year to Rmb3.62tn at the end of April, following a Rmb1.07tn or 49% increase in 2020.

Foreign holdings of Chinese bonds

Source: China Bond Connect

While Stock Connect “Northbound” net inflows have totaled Rmb156bn so far this year, after net inflows of Rmb209bn in 2020.

Monthly Stock Connect Northbound net inflows

Source: Bloomberg, HKEx

Still, such flows raise a policy issue for the Chinese authorities.

This is the risk of excessive currency appreciation, most particularly as the PBOC will be reluctant to intervene to hold down the currency since such intervention would be stimulatory in a liquidity sense and therefore go against the current targeted tightening bias of monetary policy.

This is perhaps the context in which to view the increase in recent months in so-called QDII quotas.

The State Administration of Foreign Exchange has increased the QDII quotas by US$30.6bn or 29% from US$104bn at the end of August 2020 to US$134.6bn at the end of March.

Qualified Domestic Institutional Investors (QDIIs) Investment Quotas Granted by the SAFE

Source: State Administration of Foreign Exchange (SAFE)

Such a quota allows mainland institutional investors to invest offshore.

A similar motive to encourage more portfolio outflows explains why there has recently been talk of allowing retail investors to buy offshore securities as part of individuals’ annual US$50,000 quota on foreign exchange purchases (see Global Times article: “China mulls easing limits on overseas insurance and securities trading”, 20 February 2021).

Still, such liberalization measures will only be incremental in nature since there will be no full-scale liberalisation of the capital account so long as China is run by the Communist Party.

This is because capital account liberalisation is totally in conflict with China’s successful command economy since it implies a politically unacceptable loss of control.

The capital account issue is not just about portfolio flows.

From an inflow standpoint, China overtook America in 2020 as the world’s top destination for foreign direct investment, just as it now enjoys a record share of world exports.

China FDI inflows rose by 4% to US$163bn in 2020, while America’s FDI inflows declined by 49% to US$134bn, according to the United Nations Conference on Trade and Development (UNCTAD).

China and US FDI inflows

Meanwhile, China’s share of world exports rose from 13.3% in 2019 to a record 15% in 2020.

This is remarkable given all the recent talk about the relocation of production out of China given growing costs as well as the Trump administration’s tariffs, tariffs which it should be remembered remain in place.

But in a classic balancing act capital outflows have also risen.

In fact China last year reported for the first time since 2015 a capital account deficit totalling US$106bn.

China balance of payments: Capital and financial account balance

Source: SAFE

This is reflected in the fact that foreign exchange reserves represent a declining percentage of Chinese international assets which totalled US$8.7tn at the end of 2020.

Out of this total 28% is accounted for by FDI assets and 23% by “other investments” comprising mainly lending and trade credits. While reserve assets accounted for 39% of the total, down from 71% in 2009.

Share of China’s international investment assets

Source: SAFE

Much of this stock of lending in the “other investment” category may well be related to financing the Belt and Road Initiative (BRI) which, along with the Greater Bay Area, are two of President Xi Jinping’s key signature policies.

The Greater Bay Area is a region which comprises Hong Kong, Macau, Shenzhen and other eight municipalities in Guangdong Province.

There is no official data breakdown on BRI lending.

Still, one way of gauging it is by monitoring the foreign lending activity of China’s two main policy banks, the China Development Bank and the Export-Import Bank of China.

By 2019, the two banks had lent US$463bn offshore, according to data compiled by the Boston University Global Development Policy Center.

But the growth in lending has slowed sharply in recent years, a process doubtless accelerated by the Covid pandemic.

Thus, annual overseas lending by the two banks declined from US$75bn in 2016 to only US$4bn in 2019.

China’s overseas development finance by two biggest policy banks

Note: China Development Bank and Export-Import Bank of China.
Source: Boston University Global Development Policy Center

But that does not mean that the BRI initiative has ended.

Indeed such infrastructure projects should be expected to accelerate after the pandemic given that many recipient countries’ economies will need all the help they can get post the health crisis.

There is also clearly a strategic motive on Beijing’s part.

Thus Pakistan, which has been probably the biggest recipient of BRI funding, last year reprioritized the flagship China-Pakistan Economic Corridor (CPEC).

China also signed in late March a 25-year economic and security cooperation agreement with Iran worth reportedly up to US$400bn.

Another way of gauging BRI activity is the offshore activity of China’s leading construction companies.

China’s biggest construction company officially reported in its year-end earnings report new foreign contracts worth US$29.7bn last year, up 4.7% YoY in spite of the pandemic, and US$136bn worth of foreign projects under construction.

That is a lot of projects.

For China the BRI agenda has two objectives.

The first is commercial, namely to expand its supply lines while keeping its construction companies busy at what they do best, namely building infrastructure.

The second is strategic.

For example, access to the Indian Ocean via the building out of the seaport of Gwadar in southern Pakistan reduces the dependence on shipping oil via the Strait of Malacca.

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