Skip to main content

The Chinese yuan breaks the psychologically important seven level: what it means for China’s economy and its credit market

On August 5, the Chinese yuan (RMB) depreciated notably against the U.S. dollar (USD), breaching the psychologically important level of “seven yuan per dollar” level as China-U.S. trade tensions re-escalate.¹ Three days later, the People’s Bank of China (PBOC) fixed the RMB’s midpoint above the seven level for the first time since 2008.²

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.

Chart of how the Chinese yuan has fared against selected currencies. The chart shows mixed results for the yuan since August 2018.

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:

  1. Expectations of a more acute decline could spark capital outflow worries.
  2. 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.

Conclusion

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.

Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.

The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.

This material, intended for the exclusive use by the recipients who are allowable to receive this document under the applicable laws and regulations of the relevant jurisdictions, was produced by, and the opinions expressed are those of, Manulife Investment Management as of the date of this publication, and are subject to change based on market and other conditions. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only as current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.

Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit nor protect against loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management.

Manulife Investment Management

Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than 150 years of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.

These materials have not been reviewed by, are not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at www.manulifeim.com/institutional.

Australia: Hancock Natural Resource Group Australasia Pty Limited, Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area and United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority, Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Asset Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad (formerly known as Manulife Asset Management Services Berhad) 200801033087 (834424-U) Philippines: Manulife Asset Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. Thailand: Manulife Asset Management (Thailand) Company Limited. United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Hancock Capital Investment Management, LLC and Hancock Natural Resource Group, Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited. 

498468

Fiona Cheung

Fiona Cheung, 

Head of Global Emerging Markets Fixed Income Research

Manulife Investment Management

Read bio

Category

Tags