A Further Devaluation Of The Renminbi Is Likely Due To The Effects Of The Recent Economic Slowdown

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Includes: CHN, CN, CNY, CXSE, CYB, FCA, FXCH, FXI, FXP, GCH, GXC, JFC, MCHI, PGJ, TDF, XPP, YANG, YAO, YINN, YXI
by: Societe Financiers

Summary

Substantial growth in the manufacturing sector in March 2016 was achieved by the easing of the monetary policy in China.

To achieve the GDP growth objectives, the monetary authorities will need to implement additional fiscal incentives.

In 2016, China's economy should show solid growth in order to increase the attractiveness of the yuan as a global reserve currency.

At the G20 summit held on April 14-15 in Washington, one of the positive theses proposed the stabilization of the economic situation in China. Earlier, the Chinese authorities made a decision to reduce interest rates and the reserve requirements for all banks. Thus, the central bank has strongly reduced the risk of liquidity problems at banks and removed the stress from the banking sector, which, in turn, has promoted growth in lending and consumption.

Regulators have tightened control over software used by traders. They have also blocked twenty-four accounts which were deemed suspicious. These measures will reduce the likelihood of manipulation in trading and volatility. Thus, we should expect a slight decrease in the level of volatility in trading in the future.

We think that the motivation behind the measures taken by the central bank of China is connected with the IMF's decision to include the yuan to the list of reserve currencies. The agreement will take effect in October 2016. Giving the yuan the new status will entail an increase in foreign investment in Chinese assets in the next five years in the amount of $0.7-$1 trillion. With the transition of the Chinese economy from being export-orientation to being domestically-oriented, the People's Bank of China once again loosened the yuan against the dollar by 0.46% on April 14, 2016. The average exchange rate of the PBOC was set at the level of 6.4891 yuan per dollar.

In our opinion, the devaluation of the RMB against the US dollar occurs because the central bank of China has deliberately devalued the national currency to stimulate export growth. Exports from China grew in March by 27.5% compared with February. The decrease in February had been expected because China celebrated the New Year.

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(Source: tradingeconomics)

In March 2016, industrial production grew by 1.4% and reached the highest rate since June 2015. Because industrial production takes a major share of the economy, the positive dynamics will allow China to reach the target GDP growth rate. These data indicate the effectiveness of the undertaken stabilization measures.

Click to enlarge

(Source: tradingeconomics)

It should be noted that the recent slowdown in the Chinese economy has provoked a substantial outflow of private investment, even though the total investment in the country has increased. This may indicate the state support of Chinese businesses and the expansion of public debt. This can also imply a possibility of future additional measures to stimulate private investment.

(Source: stats.gov.cn)

It is believed that the weak spot of the Chinese economy is the troubled loans. According to the latest IMF estimates, the volume of loans underwritten to corporate borrowers in China, whose cash flows are insufficient to pay interest on the loans, amounts to about $1.3 trillion. However, do not forget that the Chinese government owns four of the largest banks: ICBC, China Construction Bank, Agricultural Bank of China, and Bank of China.

Conclusion

On the basis of recent economic data, we can conclude that China's economy is gradually stabilizing which indicates the effectiveness of the government's monetary measures. It should be understood that the government will continue to pursue measures to boost the economy's growth rate. The new status of the RMB as a reserve currency will also serve as a catalyst for this motivation. Also, to increase the attractiveness of China for private investment, the authorities will have to carry out measures to reduce the budget deficit. Therefore, we can expect carrying out fiscal consolidation before the yuan will officially become a reserve currency in October 2016.

Societe Financiers is an investment research team focused on long-term, long- and short-only ideas. Our research objective is to cover equities in various regions, such as North America, EMEA, Asia, Australia, and Emerging Markets.
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