The sudden depreciation of the yuan last week was one of the largest three-day moves in recent years.
It spooked the market in much the same way as a curious episode in December 2008, when the currency depreciated 0.73 per cent in just one day during then US treasury secretary Henry Paulson’s visit to Beijing.
Another similar episode was in August 2010, when the People’s Bank of China unexpectedly raised the yuan reference rate by 0.5 per cent. In each of these moves, China markets plunged close to 2 per cent during the day and sent tremors across global markets.
It is still a mystery whether last week’s move was engineered by the PBOC or if it was the offshore hedge funds unwinding their yuan carry trades.
Our take is that it was likely to be a central bank move, as it was concurrent with a release of forex funds and declining market interest rates.
Otherwise, market interest rates should have moved higher to compensate for the depreciation in the yuan exchange rate.
Some may point out that the offshore yuan rate depreciated much more than the onshore rate. But because of different participants and a thinner market, the offshore rate has often been more volatile than the onshore one. That said, its fluctuation has been within the 1 per cent band stipulated by the central bank.
The implications of potential competitive currency devaluation are significant:
- China’s economic growth could be slowing faster than recent economic data suggested;
- it could start a trade war. Small Asian exporters such as South Korea will be affected;
- a falling yuan is bad news for Chinese property developers who have been borrowing in US dollars;
- it is deflationary and could depress commodity demand;
- it could spark the flight of capital.
While the change in expectations for the yuan has been a coincidental indicator of market performance in the past , market participants must heed the warning, if the yuan depreciation is indeed the central bank’s initiative and persists.
Property price growth, if not absolute prices, has peaked. It is an even bigger market risk.
During the weekend, one of the banks in China confirmed that it has stopped mezzanine loans to the property sector. The news shocked the market.
Even though this bank has one of the larger exposures to the property sector as a percentage of its loan book, it is possible that other banks could follow suit, or at least conduct a risk audit and slow down lending to the sector.
With the maturity date of many trusts nearing, liquidity risks are once again heightened.
Several property projects in Hangzhou have lowered their prices significantly to liquidate inventory. Historically, Hangzhou has been a leading indicator of the property sector’s health, especially for the Tier 2 cities.
When we were travelling in Hangzhou during the weekend, we noticed new residential construction has risen significantly – with scant occupancy.
Slowing sales and recent aggressive land grabs by some of the developers in the city may have induced the rush for cash and the weekend price war.
Meanwhile, official statistics on Monday showed that property prices in 69 out of 70 cities continued to rise, albeit at a slightly lower rate. Our analysis shows that property price growth of new homes has already peaked, if not the absolute price levels.
Many believe that properties cannot crash, as it is destabilising and will not be “allowed”. But the property market has collapsed before – in 2008. And this time around we cannot afford another 4 trillion yuan bailout.
Despite Monday’s plunge, market sentiment has not reached catharsis. The lowest M1 money supply growth in years was likely caused by companies moving their money away from demand deposits owing to the New Year. It is not a monetary policy turning point, as pundits hope.
The market had a small bounce after the Lunar New Year. It excited many but remained a chimera to us. Now the bounce is fading as quickly as it started. And the risks they are a-risin’.
The author is managing director for research at Bank of Communications. Follow him on Sina Weibo .