How about a significant one-off devaluation of the RMB?

September 19, 2015 08:08
Premier Li Keqiang (left) should learn from former premier Zhu Rongji, who devalued the redback by 50 percent in a one-off move in 1994. Photos: CNSA

Foreign capital continues to flee China after the recent turmoil in its stock and currency markets despite Beijing’s aggressive rescue efforts.

Hong Kong and China funds reported outflows of HK$11.6 billion (US$1.5 billion) in the week to Sept. 10, although the Hang Seng Index rebounded more than 1,400 points on Sept. 8-9.

Meanwhile, the index of A shares has fallen in the past month from 4,000 points to a little above 3,000.

Could it be stabilized at 3,000 points?

The market is already distorted, and the central government is trying to alleviate the selling pressure and cleaning up off-market financing.

To lure foreign investors back to the China market, the valuations of A shares and H shares have to drop to extremely cheap levels, at which foreign investors would consider them “distressed” stocks.

For example, some funds made long-term investments when the Hong Kong market tumbled to 20,500 points recently.

It remains unclear whether they are making further investments.

The A shares appear to have stabilized at 3,000 points and staged a 4 percent rally Wednesday amid rumors that the government may relax its crackdown on off-market umbrella trusts and other financing products.

If Chinese companies are reluctant to sell assets at extremely low prices to foreign investors, they have to come up with wonderful stories to create the momentum to drive up the market.

Local and foreign investors may not be interested in A shares and H shares until market confidence has been restored.

The Chinese currency has followed a pattern similar to that of the stock market.

We believe Premier Li Keqiang should learn from former premier Zhu Rongji, who devalued the redback by 50 percent in a one-off move in 1994.

The renminbi not only stabilized at that level back then but crept up gradually and rebounded more than 50 percent.

Daiwa Capital Markets has expressed the most pessimistic view, noting that China’s economy has serious problems, as indicated by the staggering declines in China’s port throughput, company orders, retail sales in Hong Kong and gaming revenue in Macau.

It believes the economy is facing a “hard landing” or even a financial crisis.

So, various market rescue measures by the government have had a limited impact. And capital continues to flee from China.

But any capital controls would be a big setback for China's policy regime.

Even if Beijing could utilize fiscal measures to fix these issues, China could face worsening depreciation of the renminbi.

The country has about US$3 trillion in US treasury securities, and a strong US dollar will exert pressure on the Chinese currency.

If China sticks to its foreign exchange rate regime, it could trigger bond deflation and cause various issues at home.

If the government lets it float, the renminbi could slump to 8.3 against the US dollar, a level we saw in 2005.

Beijing has expended massive capital in stabilizing the equity and currency markets, rather than on the real economy.

That will also affect the redback.

Daiwa has been right for all its forecasts on China’s economy so far this year.

It’s a good buying opportunity when the market is most bearish, as there is no more major bad news to come.

Li should consider a one-off, 10-20 percent devaluation of the renminbi.

That would not only stimulate China's export sector but also stem bearish expectations for the currency.

In fact, market expectations could turn positive, which would trigger a strong rebound in China's equities and currency.

However, it may not easy to take that approach given current market conditions.

Will the US tolerate such a devaluation?

Europe and Japan can launch quantitative easing programs, but not China.

Beijing has stated it will stabilize the domestic economy, equities and currency before President Xi Jinping's summit with US President Barack Obama in Washington.

This article appeared in the Hong Kong Economic Journal on Sept. 17.

Translation by Julie Zhu

[Chinese version中文版]

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Founder and Managing Director of Pegasus Fund Managers Ltd.