The People’s Bank of China announced last Sunday that it was cutting the reserve requirement ratio (RRR) for banks, the fourth such move this year.
It remains to be seen whether the easing move will help bolster economic growth, but the news certainly exerted immediate pressure on the currency exchange rate.
The onshore yuan tumbled to a 19-month low against the US dollar on Monday.
Will RRR cut push the dollar-yuan exchange rate to beyond 7?
Although the exchange rate historically moved largely in tandem with that of the RRR, I don’t believe there is much room for further RRR cut.
China’s private sector credit to GDP ratio has soared to 2.13 in the first quarter of this year from 1.14 in late 2008, according to BIS data. That has already exceeded the level of Thailand at the height of 1997 Asian Financial Crisis and that of US in 2008 financial crisis.
As such, any additional easing efforts would be restrained given the risk of worsening the credit bubble. Instead, policy initiatives would likely shift focus to tax cuts and fiscal spending to stimulate growth.
But that does not mean the yuan won’t weaken further. In fact the chance for the dollar-yuan rate to exceed 7 is quite high — for three reasons.
First is the worsening fund outflow situation in China.
Estimated 12-month net capital outflow and hot money outlaw reached US$397.3 billion and US$332 billion by the end of July and August respectively.
And the nation’s foreign exchange reserves have tumbled to one-year low of US$3.087 trillion in September, which means capital outflow has been accelerating.
The escalating US-China trade war doesn’t help.
At the same time, the greenback continues to draw strength from the strong US economic growth and continued tightening policy there.
Higher US bond yields and a narrowing of the yield differential between the US and China will also pressurize the yuan.
A weaker yuan bodes ill for the earnings of many listed companies in Hong Kong.
According to their financial reports, around 1,200 listed firms generate over half of their revenue from mainland China. And about 860 companies generate as much as 90 or even 100 percent of their revenue from the mainland market.
Weaker yuan will thus hit the Hong Kong equity market by putting downward pressure on the earnings, raising the possibility for the benchmark Hang Seng Index to test key levels around 23,000 points, or even lower.
This article appeared in the Hong Kong Economic Journal on Oct 11
Translation by Julie Zhu
[Chinese version 中文版]
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