A sudden slide in the renminbi exchange rate has unnerved investors and prompted a sell-off on the equity markets this year. In Hong Kong, the benchmark Hang Seng Index has tumbled nearly 10 percent so far in January.
While the worries are understandable, some of the panic in the market is unwarranted.
China continues to have tight control on capital flows in and out of the country, and also in the setting of the renminbi’s daily reference rate.
Even if the renminbi depreciates by 15 percent in the year, China is unlikely to have a currency crisis, given its huge current account surplus.
As of the end of November, China had US$337.7 billion surplus in its current account. Meanwhile, the fiscal deficit accounted for less than 3 percent of the gross domestic product (GDP). Moreover the nation still holds US$3.33 trillion foreign reserves.
Amid all these factors, the possibility of a currency crisis is very low.
What the government wants is to avoid deflation risk, using the lower renminbi exchange rate.
The producer price index, a gauge of wholesale inflation, was negative 5.9 percent in December, lower than market expectation and marking the 46th consecutive monthly decline. Deflation pressures are indeed severe, though consumer inflation is holding up in positive territory.
Japan’s experience shows that deflation will not only harm the economy but impact corporate earnings. One fast solution is to devalue the currency and “import” inflation.
Downtrend of the renminbi exchange rate may come to a halt soon. With big surplus in current account, it is not necessary for China to rely on currency depreciation to give a boost to exports. Authorities may consider taking a break to observe the consequence of the recent moves.
Devaluation is not without costs. Hong Kong-listed mainland companies will see Hong Kong dollar denominated earnings decrease.
In recent years, the renminbi was in a one-way uptrend. Mainland companies opted to issue US dollar denominated bonds amid the rising Chinese unit. But the sudden devaluation may have caused a 5 percent increase in debt and 5 percent slide in Hong Kong dollar denominated earnings.
Such worries contributed to the recent sell-off on stock markets.
However, investors should understand that there are no fundamental issues that would warrant further steep losses in equity prices. Undue panic is not necessary.
While the negative impact on corporate earnings is a one-time thing, exporting companies stand to benefit from improved competitiveness.
In the coming months, even the deflation situation in the mainland could turn around and the macro picture could improve.
This article appeared in the Hong Kong Economic Journal on Jan. 13.
Translation by Myssie You
[Chinese version 中文版]
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