Authors: Winni Zhou and Ankur Banerjee

SHANGHAI/SINGAPORE (Reuters) – The depreciation of the yuan and a significant cash outflow from the mainland to Hong Kong show that domestic investors in China are putting off expectations for an immediate recovery in their domestic markets and fleeing to nearby, higher-yielding assets.

The yuan fell to seven-month lows this week as capital investment flows into China reversed.

Analysts say Hong Kong’s stockpile of yuan deposits has also risen as mainland investors tap into their restricted overseas investment channels to seek higher yields and as companies prepare to pay annual dividends, adding to pressure on the currency.

“Sentiment towards China has deteriorated over the past month as the market strengthened ahead of improving macro data, which continues to disappoint,” said Gary Tan, Singapore-based portfolio manager at Allspring Global Investments.

Tan, whose funds are underweight in Chinese shares, however, said sentiment had improved significantly since the days when mainland markets were considered “uninvestable” and he expected further improvement.

However, investors’ patience ran out after months of waiting for the authorities to introduce further stimuli, mainly aimed at supporting the real estate sector that was in crisis.

The Shanghai stock index rose 20% from early February to mid-May, but has since fallen 6%.

Foreigners who returned to the market since February, after leaving in 2023, also became sellers this month, raising 33 billion yuan ($4.54 billion) through the northern part of the Stock Connect Scheme.

Domestic investors used the southern section to pump 129 billion yuan into Hong Kong.

Analysts say investors have several reasons to stop and reflect, not only on how far the People’s Bank of China will cut interest rates, but also on the upcoming July plenum of the Chinese Communist Party, which aims to shape economic and fiscal policy.

Chi Lo, senior market strategy specialist for Asia-Pacific at BNP Paribas (OTC:) Asset Management, said foreign funds, although currently positioned neutrally towards Chinese equities, are achieving positive results.

“In my view, Beijing is likely to maintain a more progressive nature of its easing measures than in the last 18 months, and the plenum is likely to reiterate this policy direction,” Lo said.

The PBOC’s daily guidance for the yuan, which it manages within a tight band, has raised speculation that authorities are allowing some depreciation to manage pressure.

This year, the yuan has lost 2.2% against the dollar.

PULL AND PRESS IN HK

As cash flows from mainland China into Hong Kong, yuan deposits in the financial center have reached record levels, with the latest official data for April showing them at 1.09 trillion yuan ($150 billion), close to peaks last seen in January 2022.

Ju Wang, head of Greater China FX and rates strategy at BNP Paribas, said mainland investors are flocking to Hong Kong in search of better yields from , given low yields in the country and expectations of further monetary easing.

Steady flows south and established transfers by Chinese companies from June to July to fund dividend payments in Hong Kong also led to foreign yuan sales and demand for the Hong Kong dollar, it said.

Since the beginning of May, the CNH has fallen 1.9% against the Hong Kong dollar.

Money is also flowing into Hong Kong in anticipation of a peak in the US dollar as the Federal Reserve prepares to ease policy, which will also have an impact on its economy due to the stability of the Hong Kong dollar.

“The U.S. interest rate cuts are very important for Hong Kong’s liquidity because of the currency peg, so once the Fed starts cutting interest rates, I think we will get liquidity here, which will push up asset prices,” said BNP Asset Management’s Lo.

($1 = 7.2610 renminbi)