Nervous about the yuan

Sidney Leng in South China Morning Post had a column on Saturday that the chances of the Chinese currency having a go at the U.S. dollar has receded considerably. The title of the article says it all. It is falling apart.

Last month, the euro surpassed the yuan to be the second most active currency in trade finance, according to a monthly report from Swift, a global financial network used by banks to transfer capital, which has tracked the yuan’s progress towards becoming a global currency since 2011.

According to the report, three years ago, when expectations for the yuan to appreciate were high, it rose to be the second most active currency for trade finance with a share of about 8 per cent. Since the yuan started depreciating in 2014, its usage has been decreasing to its current share of 4.6 per cent.

The yuan also slipped by one position in October to become the sixth most actively used currency for international payments, after the Canadian dollar.

The offshore yuan market in Hong Kong is currently shrinking, and the dim sum bond market – bonds issued outside China but denominated in renminbi – is withering.

Two months ago, Eswar Prasad wrote a piece for the Wall Street Journal and he elaborated on it for Brookings Institution. Like a typical academic, he was careful to hedge his bets. But, he must be pleased that he concluded his piece on the following lines:

The only way to convince investors is to match words and commitments with actions on the ground, and to make further progress on reforms. If China plays its cards right by adopting reforms that put its economy and financial markets on the right track, the RMB could one day conceivably become a significant reserve currency, rivaling even such reserve currencies as the pound sterling and the Japanese yen.

Even with such reforms, however, the RMB will soon reach its limits. While the Chinese leadership is pursuing financial liberalization and limited market-oriented economic reforms, it has unequivocally repudiated political, legal, and institutional reforms. Chinese President Xi Jinping’s government has, if anything, rolled back freedom of expression, the rule of law, and the independence of key institutions from government interference.

Financial Times reported today that the Chinese government is considering a proposal to restrict outbound investment. That is a departure from encouraging outbound investment in place until recently as China had too much Foreign Exchange Reserves. Now, evidently, it does not think it has enough.

The State Council, China’s cabinet, will ban outbound investment deals worth more than $10bn or mergers and acquisitions above $1bn if they are outside the Chinese investor’s core business, according to two sources who have seen a draft document outlining the new rules. State-owned enterprises will also not be allowed to invest more than $1bn in foreign real estate, according to the sources, writes Gabriel Wildau in Shanghai. [Link]

This FT article says that mindless acquisitions have led to the crackdown. Could be. But, it is also due to concern over capital flight. Lucy Hornby in FT tracks the methods by which capital leaks out of and leaves China.FT View thinks that fixes such as this won’t work for long. I am not sure about it though.

According to the State Administration for Foreign Exchange (SAFE), Foreign Exchange Reserves were around USD3,120.66bn as of end-October. It was USD3,330.362bn in end-December 2015. That is a drop of USD209.71bn this year. That explains many things.

The path of least resistance for the yuan seems to be lower (weaker) for longer. This is not an investment recommendation. Caveat emptor.

Postscript: FT has a detailed research report (unlikely to be open access) on the rising household debt. It is not alarm bells yet. But, the country is getting there. According to BIS data on non-financial debt, Household (and the not-for-profits sector) debt/GDP ratio was 19% in end-2007. By end-2015, it had more than doubled to 39.5%. All else being equal, that would lower, over time, the current account surplus (may be, even a deficit at some point?) and elevate weakness risks for the yuan.


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