image

A-shares

Chinese currency is expected to devalue by this much

PUBLISHED : Sunday, 31 January, 2016, 5:23pm
UPDATED : Monday, 27 June, 2016, 11:51am

The Chinese currency is overvalued and forecast to depreciate further, with analysts saying that further drops would make economic sense and that currency fears are overblown.

China’s currency is expected to depreciate by around 3 per cent in effective terms and 7 per cent against the US dollar to about 7 yuan per USD, according to a report by AXA analysts Laurent Clavel and Aidan Yao released recently.

Renewed appreciation of the US dollar has dragged down most emerging currencies, even the euro, as well as the yuan. Although the yuan has fallen against the US dollar by 6 per cent over the past 12 months and 3 per cent since a shock August devaluation, the currency has actually strengthened against other currencies and the overall index has broadly flattened, the report said. The yuan’s fall against the USD has been driven more by the strengthening dollar than a weakening yuan.

“We have come to the conclusion that the yuan is roughly 10 per cent overvalued. The structural change in China’s exchange rate policy allows further depreciation against the US dollar, which makes economic sense,” the analysts said, adding that China’s currency is not free-flowing and only partly open.

“The FX (foreign exchange) market liberalisation, in our view, has offered global investors a new way of expressing China fears, and created a powerful channel of transmission connecting China and the global markets.”

READ MORE: China has ‘no plan’ to devalue yuan to help exports – or start a trade war, Premier Li Keqiang tells IMF

Recent structural changes implemented by Beijing have shifted the driving force of Chinese foreign exchange policy away from yuan-dollar pegging and towards a yuan trade-weighted index consisting of 13 currencies, analysts said.

According to the report, yuan depreciation and Chinese investors looking to diversify assets overseas drove capital outflows to an estimated US$760 billion last year. Sources of capital outflow include the unwinding of foreign carry trade on offshore yuan, Chinese corporates paying down dollar debts with cheaper onshore funding and more overseas lending from local banks to support China’s Asian Infrastructure Investment Bank and “One belt, One road” development strategy.

The spread between onshore and offshore yuan may also be encouraging outflows, according to a recent report by Schroders. Offshore yuan has frequently traded 20 basis points weaker than onshore yuan since August, and the central bank has recently intervened to reduce this spread.

“Intervention aimed at reducing the spread against the offshore yuan has seen trade-weighted depreciation but this is unlikely to persist,” the report said. “The question then is whether the authorities will continue with the existing policy of gradual depreciation or pursue a more aggressive one-off devaluation, and drive down the trade-weighted exchange rate which is a bigger threat to the rest of the world.”

Other drivers of currency weakness include a natural reversal of strength on a trade-weighted basis when considering the currency’s strong performance in recent years, as well as a deliberate 10 per cent or higher devaluation, according to a report by UBS analysts. They advise investors to hedge their onshore yuan exposure in the next three to six months.

As a result of high liquidity, the A-share market is expected to give investors better returns in the second half of this year, the report said. Analysts predict total revenue to decline four per cent and earnings to decline one per cent this year, given the market’s large exposure to heavy industries and banks.

“We believe economic risks related to China have not become more unquantifiable, nor has the government lost control over the CNY,” UBS analysts said. “Value has emerged in selected A shares after the broad sell-off. Equity valuation multiples should expand slightly to offset the earnings decline.”

business-article-page