Currency depreciation as a strategic measure amid increasing economic uncertainty
To understand the RMB’s sudden weakness, we need to look at the macroeconomic backdrop of the sharp deterioration in U.S.-China trade relations and the increasingly accommodative rhetoric by major global central banks. On August 1, the U.S. administration announced a fresh round of tariffs on US$300 billion of Chinese imports to be implemented on September 1.3 The unexpected announcement came after the two countries agreed at the G20 summit in June to resume trade talks. On August 5, the U.S. Treasury Department officially named China as a currency manipulator, escalating bilateral tensions further. At the same time, major global banks have adopted the dovish tone set by the U.S. Federal Reserve (Fed), trimming growth forecasts and pledging lower interest rates.
We see the RMB’s depreciation as a one-off strategic measure by the Chinese government that’s designed to blunt the impact of rising global economic risks. This is different from the last significant devaluation back in August 2015 when comprehensive RMB pricing-and-flow reforms were introduced in order for the currency to be included in the International Monetary Fund’s Special Drawing Right basket.
Overall, the weakening of the RMB against the USD shouldn’t be viewed as an outlier, as other major global and regional currencies have also recently weakened against the greenback due to dovish central bank policies and rising geopolitical risks. Historically, the PBOC has supported the RMB, fixing the currency at a stronger level after acute market sell-offs and spending roughly US$1 trillion of its foreign exchange reserves4 over the past five years.
After the RMB’s recent dip, we don’t expect further aggressive currency depreciation for two reasons:
- Expectations of a more acute decline could spark capital outflow worries.
- The RMB/USD interest-rate gap is now widening, as the Fed is expected to cut rates further while the PBOC remains neutral.
Economic impact: policy to redistribute economic pain to stronger segments
From an economic perspective, we don’t think that a weaker RMB will lead to a material increase in growth. China’s current account has turned to a surplus of roughly 0.4% of GDP,5 suggesting that trade isn’t a major driver of growth at present. By extension, the impact of an increase in exports should also be marginal. However, the currency’s depreciation may have significant distributional impacts. A weaker RMB helps to boost margins in the struggling export sector, right at the time when it may be facing escalating costs. Conversely, it hurts the burgeoning import and consumption sector, which has driven recent economic growth. Therefore, the weaker yuan could boost social stability while disrupting a more robust segment of the Chinese economy.
Credit impact: companies with substantial non-RMB debt exposure and currency mismatches may be the most vulnerable
We believe that the impact of RMB weakness on sovereign debt markets will be quite limited: Foreign debt as a total of Chinese government debt remains quite small.6 The effect on corporate debt markets, however, may be more significant—especially for sectors or companies with large currency mismatches and unhedged foreign exchange risk and weak margins. This is especially the case if the currency remains at a lower level for a prolonged period. In particular:
- Industries that have a high exposure to non-RMB debt such as property developers and airlines. Some companies in these industries have over 30% of their total debt denominated in a foreign currency.7 Any further depreciation in the value of the RMB will lead to weaker debt-servicing ability and higher leverage levels among affected businesses.
- Companies that earn their revenue in RMB but have a USD-denominated cost base and thin margins, for instance, downstream petrochemical and pulp/paper companies could be particularly vulnerable. Consumption-related industries that rely on imports, such as luxury goods and foreign brand distributors, could also see lower profit margins or weaker demand for their products. To a lesser extent, travel-related and Macau gaming sectors may also be negatively affected due to higher costs for Chinese international travelers.
Amid the escalation of the U.S.-China trade war and the potential for a further RMB weakening, we also expect credit issuers to be more cautious with their foreign debt exposure—this could lead to a reduced appetite to issue debt in the offshore bond market.
Despite the high level of uncertainty in the macro environment, we remain constructive of the credit fundamentals of China’s corporates we cover—which are largely intact on the back of ample market liquidity. We also believe that stronger companies are well positioned to withstand any further weakness in the RMB, given their ability to access to domestic funding and having a manageable USD-denominated debt maturity profile.
1 Bloomberg, August 5, 2019. 2 The RMB trades in a narrow daily band which is defined by a midpoint fixing rate set by the PBOC every morning. 3 Tariffs on select Chinese imports into the United States (mainly consumer goods) have been delayed until at least mid-December. 4 Manulife Investment Management, August 13, 2019. The assumption based on the drop in foreign exchange reserves from 2014–2018. 5 China’s State Administration of Foreign Exchange, as of December 2018. 6 Moody’s Financial Services, August 13, 2019. 7 Information collated from company financials, December 2018.
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