Long-Term And Short-Run Challenges For China In Two Charts

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Includes: CNY, CYB, FXCH, FXI
by: Evariste Lefeuvre

Summary

The recent devaluation of the Renminbi has raised two different kinds of questions.

How far will the USD/CNY go? How serious are the economic problems and challenges that China is facing?

Those issues can be summarized in two charts.

The recent devaluation of the Renminbi has raised two sets of questions. How far will the USD/CNY go? How serious are the economic problems and challenges of China? Two charts can provide a lot of answers to those questions.

1. Structurally, there is a big issue regarding:

a/ The return/efficiency of capital (something well illustrated by the ICOR: a higher figure suggests a lower marginal efficiency of new capital). The sharp increase registered since 2008 suggests that the efficiency of newly added capital has drastically fallen.

b/ This is a big issue since it has been financed by a sharp increase in leverage. The trend of the associated debt load, as a share of GDP, has drastically steepened after the Great Recession.

The message is clear: there is a double structural issue for China: a combination of inefficient capital accumulation with a huge debt hangover.

2. Cyclically: Capital outflows (proxied here by cumulative changes in FX reserves and the trade balance) are huge. The link with the USD/CNY has historically been loose but significant, which is quite surprising given the administered FX regime. The current reading clearly points toward a much weaker Yuan.

Here too the message is straightforward: If "market forces" have to drive the USD/CNY, the depreciation will continue.

Two charts thus to highlight the short-term risk of depreciation and the long-run challenges of China, suggesting that it won't be the global growth enhancer that it used to be.

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