JP Morgan Asset Management Chief Asia Strategist Tai Hui comments on how investors should interpret China’s currency devaluation
The PBoC’s move should be seen as further liberalising the RMB as China continues to justify the RMB as part of the IMF’s Special Drawing Rights (SDR) currencies.
As China’s domestic capital markets become more developed, the PBoC believes it is time for the market to play a bigger role in deciding the exchange rate in order to better reflect market demand and supply. The central bank has highlighted that they would like to give more weight to the mark-to-market pricing mechanism because the reference rate has shown significant deviation from the market spot rate for a prolonged period of time.
While some investors could interpret the latest move as additional stimulus to support weak export performance, we believe yesterday’s announcement should not be viewed as “competitive devaluation” because this is a risky strategy for various reasons.
First, the benefits of boosting exports in today’s low global growth environment does little to stabilise the Chinese economy as policy makers have sufficient fiscal and monetary stimulus measures in place to boost domestic demand if deemed necessary. Second, fragile onshore investor sentiment after the stock market rout in the past two months could be further undermined by a depreciating currency.
China’s foreign exchange reserve has fallen by $127bn since the start of 2014, to $3.7tn. This remains a strong buffer and part of the capital outflow is a result of liberalisation of its outward direct investment by Chinese companies, but an increase in hot money outflow could still poses a challenge to policymakers.
Third, the rise in hard currency debt issued by Chinese companies could also face pressure if the RMB devalues significantly. While the possible hike in interest rates by the Federal Reserve later this year is likely to be modest and manageable, exchange rate volatility will become be a much bigger challenge for companies to manage in the longer-term.
We maintain our view that large scale RMB devaluation would do more harm than good to the economy as well as foreign investor sentiment. As such, yesterday’s announcement should be seen as a complement to China’s ongoing capital account liberalisation.
China’s weaker-than-expected export performance is in line with the global trade cycle in the past 6-12 months, and it is doubtful that a 2%currency depreciation can help stabilise the economy. Given the recent weakness in the Chinese economy, both monetary and fiscal policies are becoming more accommodative as the Chinese government knows that economic growth in the second half of 2015 should be more driven by the domestic economy as opposed to relying on external factors.
Since China is not aiming to engineer a weaker RMB, the sharp depreciation pressure on other Asian currencies should also fade in the short term. However, as the PBoC slowly lets the reference rate to adjust further based on market forces, we believe currency volatility will increase, which should also affect other Asian currencies to become more volatile in the longer term.”