19 January 2019
China has to protect the renminbi exchange rate, even at the expense of the stock markets. Photo: CNSA
China has to protect the renminbi exchange rate, even at the expense of the stock markets. Photo: CNSA

An unspoken choice for China

The Shanghai Composite Index wiped out all its gains last year after another 6.4 percent dive Wednesday.

The index closed at about 2,700 points, and many analysts expect it to fall to 2,400.

Investors are the victims.

Their confidence in the A-share market is exhausted.

Investors in the mainland stock markets can only hope for supportive policies from the government, instead of improved company fundamentals and earnings outlooks.

Unfortunately, the mainland authorities’ measures to rescue the market mostly turned out to have the opposite effect.

In the short run, I don’t think the government will intervene in the stock market to prevent it from falling further, because Beijing has a hard choice to make.

When stock market plunges synchronize with a devaluation of the renminbi, which should the government choose to save first?

The decision-making logic is simple and straightforward.

Given that the stock markets are part of the securities markets and the financial markets, ups and downs in them are natural.

Although they will affect individuals, corporate financing and social wealth, the risk is basically under control.

The renminbi exchange rate is more crucial.

Unlike buying or selling stocks, people and companies in the mainland don’t have a choice of currency.

The government’s controls on the currency have a larger influence on the exchange rate, as the renminbi is not yet fully convertible.

If the trend of renminbi devaluation is confirmed, capital will inevitably flee from the mainland property market, stock markets and other asset classes.

Big speculators like George Soros are now targeting the renminbi exchange rate.

Hongkongers should be familiar with his tricks. What we learned from the 1997 Asian financial crisis is that to keep the exchange rate stable, asset prices have to be sacrificed.

China cannot solve its economic problems in the short run.

Its producer price index has declined for five years in a row, while the consumer price index is at only 1.5 percent.

One influential factor on the CPI is the Labor Contract Law which came into effect in 2008.

It has led to a 10 percent increase in salary every year.

Excluding that factor, the mainland is in severe deflation, while the destocking process has not yet been completed.

So, the Chinese stock markets are paying the price to defend the renminbi exchange rate.

This article appeared in the Hong Kong Economic Journal on Jan. 28.

Translation by Myssie You

[Chinese version 中文版]

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head of private banking and trust services at Hang Seng Bank

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