Funds Will Flee China as Yuan Gains Cool, Martin Currie Says

By Judy Chen

Sept. 24 (Bloomberg) -- Overseas investors are repatriating funds from China as the U.S. credit crisis starves them of capital and yuan gains are reined in to help the economy, according to Martin Currie Investment Management Ltd.

The currency has risen 0.45 percent against the dollar since the end of June, set for the smallest quarterly advance in more than two years, as China limits its appreciation to help exporters weather a slump in global demand. The yuan has jumped 21 percent since a peg to the dollar was scrapped in July 2005, helping draw speculative capital from abroad.

``Foreign investors are pulling money out of China, initially because of the financial crisis,'' said Chris Ruffle, who is based in Shanghai and helps oversee about $3 billion of assets as co-chairman of Martin Currie's China unit. ``The next round will be when it becomes apparent that the currency will no longer go upward.''

Premier Wen Jiabao said on Sept. 20 that China will step up economic controls as the country seeks to shield itself from global financial volatility. A loss of confidence in credit markets forced Lehman Brothers Holdings Inc. to file the biggest bankruptcy in history this month and prompted the U.S. government to nationalize the nation's No. 1 insurer by assets as well as the two largest mortgage-financing companies.

Excessive Outflows

China's CSI 300 Index has slumped 61 percent this year, the second-worst performing stock benchmark in the world. Ukraine's PFTS Index is the biggest loser, having plunged 67 percent.

Shares aren't the only assets that are out of favor in China. The proportion of Chinese households planning to buy a home is the lowest since at least 1999, according to a quarterly central bank survey published this week. Property prices in 70 major cities rose 5.3 percent in August from a year earlier, the smallest gain in 18 months, official figures show.

China should prevent ``excessive capital outflows from stock and housing markets,'' Chen Dongqi, deputy director of the National Development and Reform Committee's Macroeconomic Research Institute, said at a conference in Shanghai on Sept. 12. He noted that speculative capital flowed from China in June, and possibly July and August as well.

The yuan dropped 0.15 percent, the most in three weeks, to 6.8238 a dollar as of 1:17 p.m. in Shanghai, from 6.8135 yesterday, according to the China Foreign Exchange Trade System. Traders are betting the currency, which climbed 10 percent in the past year, will gain 0.8 percent in the next 12 months, according to non-deliverable forward contracts.

The contracts are agreements in which assets are bought and sold at current prices for settlement at a later-specified time and date. Non-deliverable forwards are settled in dollars rather than the underlying asset.

Economic Downturn

Expectations for yuan appreciation have cooled as China's economy, the fourth-largest in the world, slows. The People's Bank of China reduced the one-year lending rate to 7.20 percent from 7.47 percent on Sept. 15 after growth eased to 10.1 percent in the second quarter, the least in more than two years.

``If the economy gets really bad, the government will be under pressure to stimulate the economy,'' said Ruffle, who began to invest in China's yuan-denominated A shares in 1997. ``One way is to let the yuan depreciate.''

China has managed the yuan's exchange rate against a basket of currencies that includes the euro, the yen and the pound since a fixed-exchange rate to the dollar ended three years ago.

Slowing appreciation and a worsening economy may encourage local investors to seek opportunities beyond China, according to Ruffle. China allows domestic funds to invest overseas under the so-called qualified domestic institutional investor, or QDII program.

``When you see the yuan will be flat and perhaps going down, you may want to diversify risks,'' said Ruffle. ``Towards the end of this year, QDII will become popular.''

To contact the reporters on this story: Judy Chen in Shanghai at xchen45@bloomberg.net