The market has been focusing on the foreign debt burden of Chinese companies after the central bank allowed a 2 percent drop in the value of the renminbi on Aug. 11.
However, investors seem to have ignored another major implication of the currency’s depreciation — a weaker yuan will affect the earnings of Chinese companies.
In July 2005 China kicked off its foreign exchange reform and allowed its currency to appreciate. The redback rallied almost 10 percent by end of 2007.
That meant that Hong Kong-listed Chinese companies posted a 5 percent growth in earnings per share every year due to the currency appreciation, even if they had no real earnings growth between 2005 and 2007.
On the other hand, their EPS are expected to fall along with a weaker Chinese currency. Over the last week, these companies have lost 4 percent of their earnings in Hong Kong dollar terms.
If we assume the yuan will depreciate 10 percent in the next 12 months, their Hong Kong dollar-denominated earnings will lose 10 percent next year.
Hong Kong firms can’t be insulated from a weaker yuan. Local fashion company I.T (00999.HK) said it has suffered HK$60 million in exchange loss for converting 1.2 billion yuan (US$187.6 million) of deposits to Hong Kong dollar.
It’s the 10th anniversary of renminbi’s foreign exchange reform, and the Chinese currency has followed a path of appreciation during that period. That’s why the recent reversal has triggered so much volatility.
You will recall that CITIC Pacific bought a huge amount of foreign exchange “accumulators” in the wake of a strong Australian dollar, but suffered heavily when the Aussie tanked in 2008.
Indeed, many companies may suffer massive financial investment losses because of the weaker yuan, and it remains unclear if I.T has made a good decision as it depends on whether the redback would depreciate further.
The currency devaluation has also rippled across the local housing market, which has kept surging after the financial crisis amid the low interest rate and limited supply.
Rising income stemming from robust tourism and retail sectors has also underpinned the housing market boom.
However, Hong Kong’s retail sector is now struggling as a result of China’s slowing economic growth and the restrictions imposed on mainland tourists. A weaker renminbi will make things worse.
Hong Kong will become less attractive than other travel destinations like Europe, Japan, Australia and South Korea because of its currency’s peg to the US dollar, which makes Hong Kong goods more expensive for mainland consumers.
The unemployment rate may also spike if the retail and tourism sectors fail to stage a rebound. If that happens, how will Hong Kong be able to sustain its high home price levels?
The Federal Reserve will only take into account its own needs when making interest rate decisions.
The Fed rate cut in 1994 bolstered Hong Kong’s already booming housing market. On the other hand, any US rate hike will weigh on Hong Kong’s economy and make housing more unaffordable for ordinary workers.
In response to the 4 percent slide in the renminbi exchange rate, other currencies have also depreciated and almost offset the impact of the devaluation.
Over the past year, global currencies have weakened against the US dollar by about 20 percent in an orderly way. Is it possible that emerging markets will see massive capital outflows as the renminbi has joined other depreciating currencies?
What worries the market most are the uncertainties rather than the risks.
The market can absorb a 5 to 10 percent depreciation in the Chinese currency, which has been overvalued by almost 20 percent.
However, it could trigger currency war in the region, which may heighten the volatility in the foreign exchange market.
More importantly, Hong Kong may further lose its competitiveness as a result of the rising dollar and weaker yuan.
This article appeared in the Hong Kong Economic Journal on Aug. 19.
Translation by Julie Zhu
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