The policy shift towards the halt of capital flight from encouraging companies to go abroad and buy up foreign assets is the least negative option that could adversly impact the Chinese economy.
That's the view of Claudia Calich, portfolio manager of emerging markets bond at M&G Investments.
'The policy shift is the least negative option for the authorities,' Calich told Citywire Asia.
'The other options would have caused a more negative impact on the economy, namely: allowing for a much faster pace of currency depreciation which could have increased financial volatility.
'A faster depletion of international reserves, which would be a credit negative; higher interest rates and/or tighter domestic liquidity, which would be negative given the large amount of domestic borrowing.
'Overall the response has been the most appropriate given such constraints.'
According to Calich, the recent tightening of capital controls in China has been driven by larger outflows from residents, both corporate and private, which started over a year ago.
'China’s current account surpluses have declined over the years as the country rebalances from an investment-led to a consumption-led economy.
'As a consequence, capital flows, as opposed to current account flows, are more important now than in the past in terms of determining the flows of US dollars in and out of the country and the amount of its foreign exchange reserves.'
The People’s Bank of China (PBoC) has managed to engineer some depreciation on the renminbi since moving away from having it trade purely vis-à-vis a US dollar basket to a broader basket that better reflects China’s trading patterns, according to the bond manager.
'The authorities have proceeded with a gradual adjustment to avoid large currency movements and market disruption, and this adjustment takes time.'
Calich believes that the capital flight trend will persist until residents believe that the currency offers an attractive risk-reward as opposed to potential returns on non-renminbi assets.
'As the US Federal Reserve continues normalising policy rates, higher rates are making the US dollar more attractive. However, the PBoC has also been raising its open market rates and this will help to keep the interest rate differential between China and the US in line.'
Calich's portfolio held some exposure in the country to corporate issuers and financials a year ago, but has since rotated into other markets.
'As we find better investment opportunities in other countries,' she said. 'However, should valuations become attractive again, we would consider adding back some exposure to China.'