Across The Border

Current yuan depreciation is still liveable but could become insidious, warn analysts

As renminbi continues dropping, investment portfolios will need to be adjusted, most vulnerable would be the currencies of major exporters to China

PUBLISHED : Friday, 04 November, 2016, 7:08pm
UPDATED : Friday, 04 November, 2016, 9:26pm

Global investors have remained surprisingly calm so far about the recent devaluation of the yuan, easing earlier fears of a so-called “hard landing” for the Chinese economy.

But some analysts are now warning of a potential spillover effect, if the currency is allowed to keep falling at its current pace.

The yuan fell to a six-year low of 6.78 to the greenback last Tuesday, marking a total 1.6 per cent depreciation during October, its biggest monthly fall since May, and 3 per cent lower than June.

However, unlike the 2 per cent one-off weakening of the yuan’s mid-price fixing conducted by the People’s Bank of China (PBOC) on August 11 last year, which shocked investors and caused widespread investment market panic, many have felt the market can still live comfortably with a steadily downward movement in the currency.

Chen Long, an analyst with Gavekal Research, says investors now widely believe the yuan’s recent weakness stems almost entirely from the strength of the US dollar, rather than any clever ploy by Beijing.

While the renminbi has been steadily falling against the dollar, the CFETS index, which measures the yuan against 13 major trade currencies, has remained steady in the last four months at between 94 and 95.

“Some suggested last August, when the PBOC imposing that big one-off devaluation, that the bank was losing control of the currency, that there was a “collapse” scenario, which would create

the proverbial deflationary shock ...but investors have since found some of those fears were unfounded,” he said.

Despite those hard landing fears circulating globally until the first quarter of this year, the country’s macro economy is still doing well.

GDP growth has been steady at 6.7 per cent in the first three quarters with a strong property market and government spending keeping growth above its target level.

Industrial profits have partly recovered, thanks to higher commodity prices and an easing of deflationary pressure, illustrated well by the producer price index turning positive for the first time in more than four years in September.

But some now suggest all that progress could start to show cracks if the yuan continues to depreciate further against the greenback, as investors adjust their portfolios.

“The limited spillover from the yuan’s depreciation so far is for the most part, not a surprise,” analysts with Bank of America Merrill Lynch said in a research note issued on Tuesday.

“The past six months have shown that a strong US dollar, weaker yuan and stable risk conditions can co-exist ... however, with our new USD/CNY forecasts well above the implied forward rate and consensus view, we caution against complacency on any yuan spillover.

CNY is the abbreviation of onshore yuan, and offshore yuan is referred as CNH.

Bank of America Merrill Lynch expects the Chinese currency to depreciate further throughout 2017, and has forecast onshore yuan at 7.25 against the US dollar with offshore yuan weaker at 7.3.

“As Beijing’s policy preference for allowing depreciation becomes clearer, portfolios will need to adjust to the deflationary consequences ... most vulnerable would be the currencies of major exporters to China, including the Australian dollar, Korean won and Singapore dollar, where we have recommended short positions,” its note said.

Most vulnerable would be the currencies of major exporters to China, including the Australian dollar, Korean won and Singapore dollar, where we have recommended short positions
Bank of America Merrill Lynch note

The two major reasons supporting its forecast include China’s policy-easing demands and continued capital outflow pressure.

“Our economists believe that officials will rely more on currency weakness than monetary or fiscal stimulus to support growth ... we believe capital outflows are here to stay and will drive the RMB down a multi-year depreciation path,” the note said.

But some others suggest the PBOC remains vigilant of financial stability risks.

Just before the end of October, China’s bank card monopoly UnionPay said it was banning the use of its credit and debit cards to buy certain insurance products overseas, a move interpreted by analysts as a way of stemming capital outflow which has intensified in recent months as the yuan’s depreciation escalated.

Aidan Yao, senior emerging Asia economist at AXA Investment Managers, said: “The central government is using the tightening tools flexibly, to prevent disorderly movements in the yuan and capital flows.”

Analysts at HSBC have maintained their year-end 2016 forecast for the yuan at 6.80 against the US dollar, saying the exchange rate is now very close to two important levels, specifically the 6.79 record-high level for USD/CNH (when it was launched in 2010), and the 6.83 level at which USD/CNY was stabilised during the global financial crisis (between July 2008 and June 2010).

“Should broad US dollar strength continue, we expect these levels to be tested. However, we also believe the PBOC could put up some temporary resistance,” they said in a note last week.

“The authorities (tend to) allow USD/CNY to reflect market forces until speculation becomes overly one-sided, thereby requiring stronger intervention to stabilise foreign exchange flows.”