Compared with the recent turmoil of double-digit currency devaluations and political unrest in other emerging markets, a modest fall this week in China’s currency was an unlikely cause for global alarm. But, as with many things, China is different.
An unexpected slide in the renminbi – supposedly carefully managed and stable – led to a surge in speculation about Beijing’s control over the world’s second-biggest economy and rattled financial markets, at least until attention was diverted by Ukraine.
In the past nine trading days, the renminbi has dropped around 1.4 per cent against the dollar to Rmb6.14 – levels not seen since last summer. The week-long fall is the steepest since 2005, when China unhooked its currency from the dollar.
Whether the currency’s drop is just a blip or hints at bigger problems will be crucial for other emerging markets – with greater use of the renminbi increasing contagion risks – and in turn developed economies.
How much the world should worry is a controversial question, however.
“The majority of people are sanguine and then there is a small group which is highly critical. It is not that they are looking at different data – which we all know is opaque – but it is differences in interpretation that make some people very worried,” says Andrew Milligan, head of global strategy at Standard Life Investments. “It is difficult with China to have shades of grey.”
The renminbi was long viewed as a one-way bet. Since China last loosened the controls on its exchange rate in 2010, the currency has risen 10 per cent against the US dollar. That slow, steady appreciation was backed by rising capital inflows, strong economic growth and the broader feeling that China had arrived as a global powerhouse.
China’s currency has also been carefully managed by the government. Its exchange rate is fixed each day by the central bank and can only rise or fall by a maximum of 1 per cent. Such low volatility, and the near-guaranteed appreciation, made the renminbi a popular and lucrative bet, especially for those willing to take on leverage or dabble in structured products, hundreds of billions of dollars of which have been sold by banks in the past year.
While this week’s currency decline might appear small, both the speed and the direction have made it a seismic shift. Scotiabank analysts described the move as a “bloodbath”.
Some investors have sensed something sinister, and raised concerns that China was seeing a rapid outflow of capital as economic conditions worsen. Recent data showed manufacturing in contraction and a property market on the turn. Worries about rising defaults in the shadow banking system have heightened fears that China might yet face an economic hard landing.
The currency sell-off also carries echoes of last June, when a spike in China’s interbank lending rates upset markets worldwide. At one point, overnight borrowing costs within the mainland leapt to 25 per cent, with some questioning whether the whole Chinese financial system was cracking after years of rampant credit growth.
My guess is that this [currency slide] is deliberately engineered, it is not an accident since they [the Chinese authorities] have managed the process of appreciation extremely well. But the amount of things going on in China means it is very difficult to interpret
– George Magnus, a senior adviser at UBS
Chinese authorities themselves have said that “market forces” are behind the move in the renminbi. The State Administration of Foreign Exchange (SAFE), which manages China’s FX reserves, said the week-long drop was nothing unusual and should not be over-interpreted.
However, most China-watchers believe the currency slide is not a symptom of some deep malaise, but rather an engineered policy by the authorities to stamp out currency speculation, introduce two-way volatility and stem the tide of “hot money” inflows. This week’s move could also pave the way for a widening of the daily trading band.
“My guess is that this is deliberately engineered, it is not an accident since they have managed the process of appreciation extremely well. But the amount of things going on in China means it is very difficult to interpret,” says George Magnus, a senior adviser at UBS.
“It’s very different from June. If it’s the financial system crashing, you should see interbank rates moving higher,” says Wei Yao, China economist at Société Générale. Current interbank lending rates are at their lowest in almost 12 months, and have fallen sharply since the start of the year. “It is intervention from the central bank,” Ms Yao adds.
Hamish Pepper, FX strategist at Barclays, says the People’s Bank of China and SAFE remain in control of the market, and are using their weight to ward off speculators.
“What the PBoC are trying to do is break the assumption in the market that the renminbi will always appreciate,” says Mr Pepper. “We’re still talking about a very managed exchange rate . . . That control that they have in the foreign exchange market is just one example of the control that they have over the broader economy.”
For fresh clues about China’s prospects, investors will watch closely next week’s National People’s Congress, which is expected to provide guidance on 2014 growth and the economic reform plans. Regardless of the outcome, many will remain wary.
“Is there a problem or two with China? Yes, there are a series of complex problems,” says Mr Milligan at Standard Life. “Are they likely to erupt into a crisis in the near term? Probably No. Does this mean the Chinese economy is likely to slow because the authorities have less room for manoeuvre? Certainly.”