Emerging markets got a minor shudder when on Wednesday last week the Chinese yuan suddenly depreciated by 1 percent in a single day. In the past such depreciation has been spread over several weeks, if not months.
It barely moves 0.2 percent in a day with the Chinese People Banks of China (PBoC) setting a daily band of movement for the currency at 0.2 percent of the previous day's closing.
Also Read: Will depreciating Yuan take toll on other Asian currencies?
Does this sudden depreciation indicate that China is worried about its slowing growth? A large part of the slowdown in China has been caused because yuan's steady appreciation at a compounded annual growth rate (CAGR) of 3.5 percent since 2005 and that has now begun to dent Chinese exports. But this ties in with China's long-term goal of shifting away from dependence on exports to dependence on domestic consumption.
CNBC-TV18 spoke to Arnab Das, MD, Roubini Global Economics, Richard Titherington, JP Morgan and Chetan Ahya, MD, Morgan Stanley Asia Pacific to know what financial markets expect from the world’s second largest economy and whether China is rethinking its strategy altogether.
Below are the excerpts from the interview:
Q: Why did the PBoC allowed such a sharp depreciation of yuan last week? Should we expect more of this?
Das: There are different things going on. One, the devaluation is being used to discourage hot money capital inflows, two, putting a tap on the accelerator to regenerate some steam in the slowing economy.
However, against the backdrop of trying to promote exports and discourage capital inflows, the underlying policy theme that Chinese authorities have recognised is that they must rebalance the economy away from the exports to the west and the United States in particular and also away from very heavy investment in construction towards consumption.
I think what they are grappling with is that transition is difficult and involves significantly slower growth. At the same time the process means that the accumulated stock of directed credit which is turning into bad loans will be a problem. So, they don’t want to have an avalanche of that problem. If they can keep a bit of investment process and a bit of export process going, they can help manage all these things more smoothly.
Q: Do you think it is as long-term as this because there are some people who believe that the depreciation was a transitory one off thing? How have you read the yuan depreciation last week?
Titherington: I think the PBoC – the Chinese central bank was a bit concerned about the extent of the flows into the yuan, particularly the offshore yuan – the CNH and they want to remind people that the currency can move in two directions and so, it is not one way bet. The weakness that you have seen whilst it has made the market very nervous is more likely to be transitory rather than a fundamental change in direction.
Q: Should we interpret this as a means whereby the Chinese are trying to get back some export markets because they are worried about slowing growth?
Titherington: No, I don’t think that is likely and that is certainly not our base case.
Q: What is your sense on the yuan depreciation?
Ahya: This is essentially aimed at checking the speculation on one way bet. Also, China's current account surplus has narrowed quite significantly. Now, it is about 1.8-2 percent of GDP. To that extent, they need to get the market prepared for a two way movement. It is no more like a huge current account surplus which means that they have to continuously appreciate. To ensure that the market gets enough notice on the two way movement, they have engineered this intervention.
The fact that this is engineered by them is also reflected in the fact that the interest rates in the interbank markets have collapsed quite a lot. Other emerging markets currency used to depreciate with lack of confidence and the interest rates in the domestic market also used to move up. With respect to China, the interest rates are going down, so, this is definitely done with a lot of control by the central bank and is really targeting the speculators.
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Q: How would you generally expect the movement of the yuan? For 2014, would it move towards 5.9 from the current 6.1 or does it go towards 6.2? Is the broad direction of yuan appreciation under threat?
Ahya: Not really. We are in our base thinking of it moving down to 5.9 but we must caveat that it will be dependent on what happens to the exports. If exports weaken a lot they are right now growing at close to 5-8 percent year on year but if they start contracting then they might change the track in terms if where the currency goes. The second issue is more related to the risk factor which is that China is trying to engineer a soft landing in its credit bubble.
The credit to GDP number is at 240 percent and when they are trying to slow the credit growth it is going to be very challenging in terms of the way they get the response from the domestic market and growth data points. That is the other thing that we will watch - the response of domestic demand to tightening of credit they are implementing.
Q: Some of the larger problems that we normally worry about China are the shadow banking problem. One wealth management programme already bombed and created some headlines. Will we see anymore accidents in the financial markets because of the shadow banks, the NBFCs?
Titherington: Over the last few years credit has built-up substantially. As authorities have tried to control that credit growth, you have seen the rise of wealth management products, shadow banking and other forms of unsecured lending. The authorities are worried about it and are trying to crackdown on it. You will see bankruptcies, you will see individual companies and lenders getting into trouble but I am not expecting that crackdown on shadow banking to have a major systemic impact on the overall economy.
Q: What is your view on the shadow banking and the banking problem in China? Can it hurt growth?
Das: Things are not good enough that we won't see much appreciation pressure. If anything there may be more capital outflows and there may be more discouragement of capital inflows. So, I would not rule out that there is further lack of strength at a minimum in the renminbi but I don’t think there will be a significant devaluation led by the authorities that would import a lot of inflation and destabilise things in China and in the world as a whole a great deal.
Q: Can you add more colour to the shadow banking sector and the problems that might create in terms of impacting growth in China?
Ahya: There are two issues there. One, the fact that credit has been delivered in form of non-bank loans which is about 50 percent of total credit creation that is happening right now in China which includes wealth management funds, trust funds, interbank loans. So, all these other sources are somewhat less structured and pose a risk to the financial system.
However, the more important issue is the overall credit to GDP which is also quite high and the concern that we have is the pace at which credit to GDP is going it is unsustainable rather than the level of credit to GDP. So, the policy makers are right now cognizant of that and are trying to slow the aggregate credit.
There are two issues, one is structure of leverage and the second is the pace of leverage. To the extent to which they are trying to work on it right now will pose a risk to the growth story in China. We have seen that with what happened in the US, what happened in Japan in the early 90s. Whenever you try to control the credit to GDP it tends to be a very difficult moment because you tend to see a growth slowdown as well. So, how do you deliver when growth is slowing and at the same time you want the credit to slow as well? It is a very challenging phase that they are going through. We will be watching on the risks on this whole deleveraging in corporate sector that they have embarked upon.
Q: Can this significantly impact growth? What is the GDP number you are working with?
Ahya: Right now we have got it at 7.2 percent which is below consensus. Everybody is talking about 7.5-7.6 percent. For near term, they will still be able to deliver 7.2 percent GDP growth for 2014. However, we have just highlighted in a more thematic report on leverage on Asia that China is the country which has a downside risk to the medium-term growth outlook which consensus has at about 7 percent and that is because not only has this leverage issue come up but there is an ageing population problem as well.
China has started to see decline in its labour workforce and at the same time it is going to see a rise in age dependency which is going to be an additional challenge to maintain that 7 percent odd growth rates.
Q: Chetan is speaking about 7.2 percent. The consensus that I have heard on Chinese GDP is running at about 7.5-7.6 percent. What is your sense, can it be significantly lower?
Titherington: When you look at 2014, growth might be lower than the consensus is currently expecting. There is a big difference between growth coming in below 7.6 percent somewhere close to 7 percent and growth coming in significantly lower that that. The chances of growth coming in significantly lower are actually quite small.
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Q: As a fund manager do you think China can give emerging markets as an asset class a bad name? Can investors now dump emerging markets as an asset class because this big boy is likely to do badly?
Titherington: That is what has been happening. We have now had 18 consecutive weeks of outflows from emerging market equities, the bulk of which is coming from global emerging markets. So, investors have been pretty pessimistic about China's impact on emerging markets for some months now.
Q: What should financial markets - equities, commodities just look forward from China and the Chinese economy in 2014?
Titherington: As long as we are in a scenario of the Chinese economy slowing down that is going to be a negative for emerging market equities and commodity prices and consequently will be more positive for US equities. When you see the turn come in towards Chinese economy growth, that would be very positive for emerging market equities and might equally be positive for commodity prices.
Q: Do you think China could be staring any kind of financial crisis, any financial accident any time soon?
Das: At some point China will have a financial crisis and that will precipitate a significant slowdown in the trend growth rate of China. I am not trying to forecast that 2014, 2015 or 2016 is the year of that crisis. But the Chinese trend growth rate is in a transition from a very high and unsustainable rate to a lower and more sustainable one. It is still fairly high and probably still at a quite unsustainable rate of growth at the moment.
Now, this rebalancing that we were discussing earlier from trade and investment to consumption will necessarily entail a significant slowdown in the growth rate because consumption is such a small share of GDP that you can't have it generate the same growth just mathematically without having either a massive increase in household income or massive increase in credit in house hold sector, latter is not going to happen because we already have a credit problem and the former is quite unlikely to happen because what's going to cause that. One way or another, we are looking at a significantly slower growth rate than what we have been used to in China and that's already been happening for a period of time.
Before the crisis, growth rate was in the low double digits, since the crisis it has been in a high single digit. It is transitioning towards the mid-single digit and eventually the low single digits because becoming a richer, more mature economy. It is not there yet but there will be a crisis at some stage. No country has been able to escape financial crisis, particularly no country that's had a growth boom and a so called miracle.
Q: On this issue of financial accidents, will there be some kind of financial accidents out of China?
Titherington: As long as the Chinese government has very significant foreign exchange reserves and runs a current account surplus the chance of a major financial accident taking place in China are pretty small.
Q: What are you looking at in terms of Chinese growth in 2015 and if you could compare it with India, could both countries be around that 5-6 percent mark in a year or two?
Ahya: Not in 2015 but beyond that is possible. I would hope that India's numbers catch up more towards 6-7 percent and China will then have to transition in that range in 2016.
Q: Will there be any financial accidents out of China in the next couple of years or is the policy in quite control of the process?
Ahya: The policy is pretty much in control. What you will see in China will not be something that you saw in the US. You will probably see the evolvement in the credit bubble in China more on the lines of what happened in Japan. So, it won't be an explosive effect because they have current account surplus and have a lot of foreign exchange (FX) reserves. So, they will settle for lower growth almost at their own terms and not really being forced by the external forces like what's happened in the other emerging markets including India recently.
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