SINGAPORE: Movements in the Chinese yuan have sparked volatility in global financial markets this year, but analysts tell Channel NewsAsia that, with the Chinese authorities likely to opt for a more steady devaluation approach in 2016, market jitters emanating from the currency may not stir up as much turbulence.
Global markets were first thrown into disarray on Aug 11 when the People’s Bank of China (PBOC) unexpectedly implemented a one-time depreciation of nearly 2 per cent to its currency, fueling concerns that China was potentially engaging in competitive devaluation amid faltering economic performance.
In December, Beijing unveiled a new exchange rate index that will see the yuan valued against a basket of 13 trade-weighted currencies markets, following the International Monetary Fund’s decision to include the yuan in the Special Drawing Rights (SDR) currency basket. The PBOC also repeatedly set the daily mid-point rate, also known as the official guidance rate, for the yuan at multi-year lows, prompting expectations for further currency weakness.
Despite having seen a turbulent year, Mr Vishnu Varathan, a senior economist at Mizuho Bank, said that any concerns about how a weakening yuan could inspire more market volatility are “perhaps premature or misguided”.
The Singapore-based economist added that markets have been on tenterhooks this year simply because they were “misreading” the PBOC’s moves.
“The PBOC was trying to unhinge from the mentality that the renminbi will be stable against the US dollar no matter what. Few steps were taken this time round such as the depreciation in August and subsequent fixings which made it more volatile, and now they are creating a trade-weighted index. The reaction so far has solidified the idea that the renminbi will be more in tandem with market prices and fits very well with the yuan’s inclusion in SDR basket, the Singapore-based economist said in a telephone interview.
"Markets will soon know that the PBOC means business."
Analysts also noted that, moving forward, the Chinese central bank will likely seek to avoid the type of chaos that ensued earlier in August in favour of a more steady approach to currency devaluation, such as the daily fixing of the mid-point rate.
“I doubt the PBOC is going to do something drastic in 2016. They were pretty embarrassed by the reaction to the August devaluation so I think they will be very careful with actions they take going forward,” Mr Tony Nash, chief economist at Complete Intelligence in Singapore, said.
If the yuan depreciates gradually, the impact will be minimal as markets will have time to react, said Mr Vasu Menon, vice president of wealth management at OCBC in Singapore.
“The pace at which the yuan depreciates will impact volatility in global markets. If China surprises markets and devalues its currency again and by a bigger quantum than what it did in August, this could spook investors and cause a sharp reaction from emerging markets and their currencies, which will in turn impact other global markets,” Mr Menon said in an email interview. “Markets do not take kindly to sharp and unexpected moves and react less vigorously when the pace of change is gradual.”
KEY RISK FACTORS
Nonetheless, risks remain and one key event that will likely sway the yuan in 2016 is the rate-hike cycle in the US.
According to IG’s market analyst Mr Angus Nicholson, huge moves in the Chinese currency this year occurred during the times when the US Federal Reserve is widely expected to unveil its first interest-rate increase in nearly a decade. “As can be seen in August when the Fed is expected to move in September, and also in December. The PBOC wants to buy some flexibility away from the greenback.”
“Looking at the renminbi in 2016, we will have to watch expectations for a rate rise in the US. Markets are pricing in a more than 50 chance for a Fed rate hike in March or April and traders should be carefully looking around these times,” said the Melbourne-based analyst who is expecting the yuan to steadily lose another 4 per cent of its value against the US dollar by mid-2016. The Chinese currency has lost nearly 6 per cent of its value this year.
Economists also highlighted risks from the constant stream of capital outflows from China amid an ebbing economy.
According to estimates provided by Capital Economics, China witnessed an acceleration in capital outflows last month which totaled US$113 billion, far higher than October’s US$37 billion.
“Further outflows could become self-reinforcing and there is a risk of a sharp selloff in global markets. In other words there is potential for a bigger depreciation in the yuan in 2016,” Moody's Analytics economist Mr Alaistair Chan said in an email interview. “We think there is a 20 per cent probability that the yuan could decline over 10 per cent against the dollar in 2016.”
If a sharper-than-expected depreciation in the yuan does unfold, other big exporters in Asia may respond with similar devaluations to maintain their competitiveness against Chinese exports.
In particular, commodity-related currencies such as the Indonesian rupiah, Malaysian ringgit and the Australian dollar will be likely candidates because the export mix of these countries “is more geared towards China’s domestic consumption, relative to intermediate producers such as South Korea, Japan and Taiwan”, according to Sydney-based Mr Chan.
For now at least, a full-fledged currency war seems unlikely.
“The Japanese Yen has depreciated over 30 per cent in the past two years and other Asian central banks were remarkably disciplined by not retaliating, especially South Korea and China,” said Mr Nash from Complete Intelligence.
“So, I doubt some relatively minor activities by China will set off competitive devaluation.”
original source: http://www.channelnewsasia.com/news/business/international/why-global-markets-need/2387072.html