22 October 2016
China's stock markets were resilient after the Brexit vote, shrugging off a slide in the yuan currency. Photo: Reuters
China's stock markets were resilient after the Brexit vote, shrugging off a slide in the yuan currency. Photo: Reuters

Can Chinese equities hold up despite weak yuan?

China’s currency, the yuan, has seen another phase of depreciation after the Brexit vote last month.

On July 6, the official fixing rate fell below 6.68 against the US dollar, the lowest since November 2010. In the year to date, the redback has lost over 3 percent against the greenback.

In the meantime, the equity market has responded calmly. The Shanghai Composite Index, in fact, gained 3 percent since the UK vote. In other news, China’s foreign exchange reserves unexpectedly rose in June.

How should investors react to such complex market situation?

I believe the impact of the UK leaving the European Union has yet to be fully reflected, and there are far more uncertainties ahead of us. Since investors hate uncertainties, money is set to flee from emerging markets and risk assets.

The yuan will be affected as there could be more outflow of capital from China in the near term, compared to inflow.

Market participants have reacted calmly to the yuan weakness, as the Chinese central bank has intervened to restore stability. The CFETS RMB Index eased to 95.02 on June 30, putting it 2.19 percent lower than the level seen in late May.

The yuan has moved far less dramatically than other currencies amid the global market turbulence, and the currency remains relatively stable against a basket of currencies, the central bank said.

Chinese companies and banks need to remit money overseas to pay dividends to their offshore shareholders. Also, mainland companies remain very aggressive in outbound M&A deals. Both factors have weighed on the yuan currency.

Foreign banks must set aside reserves equal to 20 percent of the forward-trade position from August 15, according to a statement from the China Foreign Exchange Trade System. The interest rate for the reserve deposits will be zero. The move is aimed at taming onshore and offshore arbitration and preventing massive capital outflow.

China’s foreign exchange reserves stood at US$3.205 trillion at the end of last month, up US$13.4 billion from the end of May, according to data released by the People’s Bank of China. The market had expected reserves to fall by about US$24.7 billion.

Observers noted that the yuan has remained stable against a basket of currencies in June, and even appreciated sharply against the sterling and euro at the end of last month. That’s why the nation’s foreign exchange reserves in SDR terms have not fallen.

Also, some offshore long-term investors have bought the Chinese currency for asset allocation. In the second half, there will be more demand for the redback as it has been included in the International Monetary Fund’s SDR basket.

China’s equity market has close correlation with the currency. A weaker yuan usually stokes equity market decline, since yuan depreciation will put pressure on financial and property sectors due to revaluation of yuan assets.

Also, expectations of weaker yuan will lead to capital outflow and drain liquidity.

However, China’s A shares have reacted fairly calmly this time. The Shanghai market once crossed the 3,000 points level and rose by 3.32 percent on June 24.

In June last year and in January this year, the market suffered a heavy sell-off due to yuan depreciation concerns.

A-shares have rallied after the Brexit vote since it’s widely believed that the developments in Europe will prompt the US Federal Reserve to hold off on further rate hikes.

Moreover, the Chinese central bank could further ease its monetary policy to stimulate the nation’s economy.

While these are positive factors for equities, the Chinese market will however face some correction pressure given that the yuan is poised to weaken further in the short term.

Beijing will focus on stabilizing growth in the second half of this year, and supply-side reform is at the critical point.

The central government may unveil bold policy initiatives for various industries and regions and expand the opening up of the economy.

Hopefully, these measures will help revitalize growth momentum in the real economy.

This article appeared in the Hong Kong Economic Journal on July 11.

Translation by Julie Zhu

[Chinese version 中文版]

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Senior investment banker

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