Yuan under scrutiny as benefits of float mount
Currency risk looks to be back for China investors. The mainland government may be rejecting calls to allow an appreciation of the yuan but many commentators believe the country could be forced to allow a managed float with or without foreign pressure.
One-year non-deliverable forwards - an indicator of the yuan's future value - have strengthened sharply, suggesting the yuan could be worth about 8.105 to the US dollar in 12 months, an increase of about 2.1 per cent.
Equity investors are only just waking up to the implications, with attention focusing on winners and losers from any re-alignment of currency values.
According to a study by CLSA Pacific Asia, China's telecommunications carriers are set to be major beneficiaries, as they would make savings in capital expenditure and increased cash flow.
'Domestic demand-driven companies stand to be the big winners from a stronger yuan, since they carry US dollar revenue, some US dollar costs and possible US dollar debt,' the report said.
Hong Kong-listed Chinese mobile carriers - China Mobile (Hong Kong) and China Unicom - could gain about US$1 billion in cash flow savings from capital expenditure in 2007 if the yuan were fully convertible and had a 15 per cent appreciation against the US dollar.
CLSA chief economist Jim Walker forecasts the yuan will be fully convertible in 2007.
'Of the large liquid stocks, mobile operators stand to benefit the most, since they have little US dollar revenue, but sizeable annual US-denominated costs,' the report said.
In 2007, CLSA estimates China Mobile and China Unicom will outlay almost US$7 billion in capital expenditure.
If the yuan were to appreciate by 15 per cent, the two mobile companies could save about US$1 billion in capital following foreign-exchange rate adjustment.
The large majority of the mobile operators' capital expenditure comes from international vendors such as Nokia, Ericsson and Motorola, while domestic vendors account for less than 20 per cent of the their total capital expenditure.
Among the three-listed mainland telecoms carriers, fixed-line operator China Telecom stands to benefit the least as almost 100 per cent of its equipment is supplied by domestic vendors, except for its higher-end fibre-optics equipment.
The report calculated that next year China Mobile would save a whopping 2.84 billion yuan (HK$2.66 billion) in capital expenditure, while China Unicom would save 1.28 billion yuan.
China Telecom's reliance on domestic equipment means it would save far less - 470 million yuan in capital expenditure next year - if the yuan were to appreciate by 10 per cent.
After the telecoms carriers, the next biggest gainers could be oil and power companies, including China Petroleum & Chemical which has forecasted free cash flows of US$705 million, compared with Huaneng Power's $320 million and CNOOC's $260 million.
BNP Paribas analyst Eva Chu Wen-yee said appreciation would affect all listed companies that reported their earnings in yuan, as the translation into US dollars would lead to an increase.
She also said a lot of companies - particularly oil and power firms - borrowed sizable amounts from abroad and appreciation would thus benefit them significantly.
Losers in any yuan appreciation saga will be export-related companies such as Li & Fung, Yue Yuen Industrial and Fountain Set.
UBS Hong Kong and China research head Andrew Look said yuan appreciation would put the squeeze on exporters' international pricing power.
However, he said companies had been flocking to the Pearl River Delta for reasons well beyond cheap currency and labour. 'If you do see an appreciation of the yuan, they [exporters] will still be competitive,' he said.
BNP Paribas china chief economist Chen Xingdong said he did not expect the yuan to appreciate in the medium term.
Many market watchers take the view that even if the peg were to widen significantly and the yuan strengthened to eight to the dollar there would still be minimal impact on China's economy as a whole.
Ajay Kapur, regional head of strategy at Citicorp Smith Barney, said even appreciation of 6 or 7 per cent 'would be easily made up by labour productivity ... the atmospherics and aesthetics will change but nothing else will change'.
He pointed out that five years ago people were predicting the inevitable depreciation of the yuan because it was not competitive enough. Now, China has accumulated a few hundred billion dollars in foreign reserves people are expecting the opposite.
'Export growth in China is almost invariant to the currency,' Mr Kapur said.
He said it would take appreciation of 20 to 30 per cent to have really noticeable consequences but added that was extremely unlikely.