Foreign investors shy from buying(2)

'Deflate slowly'

"Meanwhile, the impact of tightened monetary policy on the real economy and the looming turning point for the real estate market also are likely to trigger capital outflow," said Du Zhengzheng, a research analyst with China Development Bank Securities.

Hou Yunchun, deputy director of the Development Research Center of the State Council, said the property market will pose the biggest challenge for China's economy this year. "The property bubble should be deflated slowly and not pricked," he said.

The government's continual measures to cool the real estate market - including increasing the down payment required and limiting the number of homes a family may buy - are working, which means they have begun to bite the real estate market.

In November, 49 of 70 monitored cities reported that prices for newly built residential properties fell from a month earlier, while prices in 16 cities remained unchanged, according to figures released by the National Bureau of Statistics.

"We expect that property investment, home sales, the floor space in new projects and land sales will all decline in the first quarter of 2012, and the correction in the real estate market will be the largest uncertainty facing the economy this year," said Gao Ting, chief China strategist at investment bank UBS AG.

RMB vs dollar

Bigger fluctuation in the renminbi is another reason for the capital outflow. In November, the yuan weakened for 12 consecutive trading days and once triggered concerns that the Chinese currency might head toward a devaluation cycle.

Zhao Qingming, a senior researcher with China Construction Bank, the country's second largest lender by market value, said a stronger yuan in 2011 was near the lower end of what he once predicted would be an appreciation of 5 and 7 percent. He expects to see bigger fluctuations against the US dollar ahead.

The accelerating withdrawal of hot money, experts said, will impose more pressure on the yuan's depreciation and will trigger bigger fluctuations in the country's stock and bond markets as well as the property sector.

"However, such an outflow is not likely to deliver a big shock to the real economy due to China's strict management of the capital account and the scale of the economy and foreign exchange reserves," said Fan Jianjun, an economist with the State Council Development Research Center.

But if the trend of capital outflows continued, analysts said, China might return to a dollar peg, as it did during the world financial crisis in 2008.

Instead of allowing for the yuan's steady depreciation, the central bank has set the middle trading price of the yuan at a persistently high level. The aim is to stabilize the yuan's value against the dollar as investors sell the currency on expectations that it will further depreciate.

"If such exchange-rate stability fails to change market expectations of a weakening yuan, it will cause more capital outflows and the situation won't ease at least until the first quarter of this year," said Industrial Bank's Lu.

According to Zhang Zhiwei, chief China economist at Nomura International, the increasing capital outflows also reflect China's shrinking trade surplus and slowing foreign direct investment in the short run.

As Chang Jian, economist with Barclays Capital, wrote in a recent research note, "Capital outflows, together with a narrower trade surplus and slowing FDI, are likely to reduce appreciation expectations and reinforce depreciation expectations, given a weakening global economy and investor sentiment."

The upside

The outflow of hot money is not all bad, however. Deprecation of RMB will give exporters a more competitive edge if, as expected, external demand plunges amid the global economic slowdown.

On the monetary policy side, it provided more leeway for the central bank to fine-tune its policy to deal with the domestic economic slowdown.

For Zhang, the capital outflow could prompt the People's Bank of China to cut the reserve requirement ratio again to offset the recent decline of foreign-exchange purchases. In December, the central bank lowered the ratio for commercial lenders for the first time since December 2008.

Zhang forecast that the central bank would soon cut the ratio by 50 more basis points and loosen requirements for banks' loan-to-deposit ratios to stabilize domestic liquidity.

For Zhou Jingtong, a researcher with the Bank of China, the outflow of foreign capital is not a major concern because "it is not a long-term trend". Zhou said the outflow will be corrected because the yuan will appreciate against a weakening US dollar in the long run.

Yi Xianrong, a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences, said that instead of focusing on the retreat of foreign capital, the government should pay special attention to the possible accelerated outflow of homegrown funds. That, Yi said, is expected to have larger repercussions for domestic monetary policy.