We’re not talking about an 80’s rock band and a Bizarre Love Triangle. Rather a world that is dealing with a massive oversupply of oil and cash, and a clunky transition for the world’s largest economy.
Saying we’ve had a turbulent start to 2016 is possibly an understatement. Nearly $7.8trillion (not billion) dollars has been wiped off world wealth. This has been even more acute for China. Persistent worries about the government’s ability to manage its economy and financial markets has lead the Shanghai Composite to be ranked as the world’s worst performing major global stock index out of the 93 tracked by Bloomberg.
After a sharp fall to more than 20% below its recent high in December, the Chinese major share indexes have recovered slightly but remain in negative territory, around 15% down.
Recent drops in the Chinese yuan against the US dollar have helped spur the volatile trading and analysts have warned of the likelihood of more volatility in the coming months. Slight gains in early trade have put the yuan 0.1% up since the start of the week, but it’s still nearly 1.4% weaker against the dollar than where it started the year, and nearly 5% lower than it was in August.
The People’s Bank of China (PBOC) has taken action to strengthen the currency, and has helped to reduce fears of a market meltdown. But investors are struggling to predict how far and how fast Chinese authorities are willing to let the yuan fall.
While some believe that China needs a one-off devaluation of at least 15 percent instead of a controlled depreciation over time, Desmond Soon, Singapore-based head of Investment Management at Western Asset Management Co. has noted that “you don’t work so hard to join the IMF reserve system and the next moment devalue your currency 10 to 20 percent.”
Two surprise yuan devaluations in six months and a cooling economy have only reinforced market expectations that something will have to give. The question remains, what?
Many investors are also concerned about the increase in capital outflows from the world’s second-largest economy as China delves into its huge reserves of foreign currency to try to tame the yuan’s movements. According to former hedge-fund manager Raoul Pal, “It’s a battleground. The Chinese are using their reserves very quickly and they have to ask themselves if they want to keep wasting money on propping up the currency.”
Chinese policy makers are walking a tightrope between making the exchange rate more market-driven after qualifying for International Monetary Fund reserve status and curbing declines to avoid capital outflows.
The PBOC has pumped 600 billion yuan (AUD $132bn) of liquidity into the banking system ahead of the lunar New Year holiday which shuts down the banks for a week from 8 February. The move was seen as part of attempts by the PBOC to keep the financial system ticking over in the wake of increasing capital flight.
On Wednesday, the central bank said that it would improve policy coordination to promote economic growth and limit financial risks, although it provided no details on steps or timing.
While China is trying to find other sources of economic growth such as services and consumption, it seems likely that they will revert back to relying on exports in the short term as as they figure out how to balance transition with growth. A cheaper currency is most certainly a way to boost exports. Taking a glass half full view, a weaker Chinese RMB should translate to adding strength to China’s economy. Given China accounts for one-third of Australian exports… we probably want this too.
