Broker's View

Stability in Chinese currency may be at an end, analysts say

Concerns that Chinese corporations are taking on too much debt have increased.

PUBLISHED : Monday, 23 May, 2016, 1:07pm
UPDATED : Monday, 23 May, 2016, 1:31pm

Market commentators said the Chinese currency’s recent stability may have ended and the yuan may weaken.

China’s currency — traded onshore — was stable in March and April at about 6.5 to the US dollar.

That stability was likely due to intervention from Chinese officials, Singapore-based Heng Koon How, a senior investment strategist at the private bank Asia Pacific, Credit Suisse, said.

All hidden risks have the potential to derail the recent stability in the yuan and drive it lower, he said.

Concerns that Chinese corporations are taking on too much debt have increased. The economic stability seen in the first quarter may be short-lived. There are rising domestic bubbles in the property sector and commodity futures markets. All these risks suggest possible further weakness for the yuan, Heng said in his report.

Worries over the quick build-up of debt by Chinese corporations have been a constant concern. China’s total debt jumped to about 240 per cent of GDP in the first quarter of 2016, from around 150 per cent at the end or 2007.

“China tends to stimulate its economy by increasing debt,” said Christy Tan, head of markets strategy and research, Asia at National Australia Bank. “There is a risk that not all debts could be repaid and the companies that issue debt may not be profitable.”

Investors buy debt because of a lack of investment alternatives on the Chinese market, but it will create different problems, Tan said.

“Basically, on the retail investor front, they lose money and may never recover it,” she said. “On the banking sector front, they may hold debts of unprofitable firms and then have problems restructuring them and that will hit the balance sheet.”

The worst thing that could happen would be a collapse in China’s financial sector, she said.

The increasing unhealthy debts contribute much to China’s GDP growth, so the economic stability may be short lived, said Heng.

“On the surface, China’s first quarter GDP growth of 6.7 per cent year-on-year was relatively commendable. However, the latest trio of high frequency activity figures suggests possible intensification of a slowdown ahead,” he said in the same report.

China’s industrial production, year-to-date fixed assets investment and retail sales all grew at a weaker-than-expected pace. The country’s April trade figures also disappointed.

The recent weakening in macroeconomic figures across April coincided with Chinese official note that the country’s economic trend will most likely be L shaped, meaning a decline followed by stability.

Economic growth slowed, but domestic bubbles are rising. The build-up of various bubbles has increased concerns that another bout of volatility may be around the corner.

“There is a stark disconnect in the strong property prices in tier 1 cities and weak property prices in lower tier cities which are still grappling with inventory oversupply,” Heng said.

Speculative bubbles have built up in China and commodities futures appear to have spread to food-related commodity futures as well, he said in his report.

A potential interest rate hike by the US Federal Reserve, central bank to the world’s largest economy, has haunted the market. Tan from NAB said, and that pressure will weigh on the Chinese currency.

“All the above mentioned developments cause us to maintain a negative view on the yuan and we expect it will gradually weaken towards 6.8 against the US dollar over the next 12 months,” he said. “Should risk aversion return, the Chinese offshore yuan will likely weaken at a quicker pace than Chinese onshore yuan.”