As the world’s attention has been fixed on Brexit and meltdown of the European financial system, China has been quietly devaluing its currency without causing too much turbulence in the financial markets as it did the last time policymakers attempted such a strategy.
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On Wednesday the yuan fell to a fresh five-and-a-half-year low against the dollar extending its slide to a fifth straight session, after China’s central bank sharply weakened its official guidance rate as the dollar surged. The yuan traded as low as 6.6955 against the dollar at one point, closing in on the psychologically important 6.7 level.
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China’s policymakers have made it clear that they are willing to let the yuan fall as low as 6.8 per dollar in 2016 to support struggling exporters, a depreciation of 4.5% for the full year matching last year’s decline.
This time around China’s central bank is trying to send a message to the markets that it has the depreciation under control. Reuters reports that traders believe state-owned banks across the country are offering dollars to soothe markets while the People’s Bank of China has been intervening in the foreign exchange market to slow down the yuan’s decline. Forex reserves fell by $27.9 billion in May to $3.19 trillion, their lowest since December 2011 although currency movements are almost entirely to blame for the decline. The renminbi depreciated by 1.8% during May. FX reserves increased by $10.3 billion during March and $7.1 billion during April.
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China: A successful devaluation?
Analysts at CLSA believe that this time around China’s policymakers will be able to devalue the yuan successfully, this time, without causing a repeat of last year’s panic. Most importantly, it now looks as if China is in control of its nominally closed capital account.
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Concerns that the country was failing to stem out-of-control capital outflows at the beginning of 2016 were one of the reasons why markets around the world went into a tailspin as the yuan starts to fall in value. There is now evidence that Beijing is enforcing its capital account controls more tightly, and FX outflows have slowed significantly.
A more curious trend is that China outward direct investment is now running at higher levels than inward foreign direct investment. During May outward direct investment hit $146 billion while FDI fell to an annualised $127 billion. CLSA believes that this trend shows that Chinese authorities are more willing to let capital flow out of the country in a controlled manner, which signifies a heightened belief by policymakers that they have the capital account outflows under control.
China’s economy is collapsing
CLSA isn’t worried about China’s devaluation but Kyle Bass, founder and principal, Hayman Capital believes that the country’s collapse is currently playing out in front of the markets eyes.
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In a recent interview, Bass reiterated his negative stance on China and highlighted that the Chinese corporate bond market has seen 150 cancellations out of 210 announced deal since the beginning of April as credit quality deteriorates across the country. Bankruptcies are up 52.5% year-on-year. According to Bass, bad loans will first cripple the banking system and then lead to a sharp devaluation of the Chinese yuan.
“How they deal with this, it’s not Armageddon. They are going to recap the banks, they are going to expand the People’s Bank of China’s (PBOC) balance sheet, they are going to slash the reserve requirement, they are going to drop their deposit rate to zero, they are going to do everything the United States did in our crisis.”
He continues:
“They are going to do what’s best for China. And what’s best for China is to materially devalue their currency.”
Only time will tell if Kyle Bass is correct on this call but one thing is clear, as the rest of the world concentrates on Brexit, China’s economy is undergoing some substantial changes.