Yuan’s woes spell trouble for emerging markets

Currency’s fall could take others with it, says analyst

“Trade and financial linkages have significantly strengthened between China and other EMS, prominently over the past decade.” Phoenix Kalen

SHANGHAI: Just months ago, the Chinese yuan was reigning supreme as emerging markets’ (EMS) own haven asset, shielding investors from the turbulence of war and runaway inflation.

Today, it is turning into a threat.

As growth sputters in the world’s second-biggest economy, its currency has tumbled to a two-year low and looks set for further losses.

This is prompting Goldman Sachs Group Inc and Skandinaviska Enskilda Banken AB (SEB), a Stockholm-based financial services group, to forecast shock waves not just in China’s immediate neighborhood but as far away as Africa and Latin America, as a weaker yuan reduces other countries’ export appeal and sparks competitive devaluations.

“With the yuan set to weaken further, other EMS will face downward pressure on their currencies,” said Per Hammarlund, the chief EM strategist at SEB.

“The impact will be felt the most by nations which compete directly with China on exports.”

The yuan declined for a sixth consecutive month in August, capping the longest losing streak since the height of the United States-led trade war in October 2018.

According to money managers such as Societe Generale SA, Nomura Holdings Inc and Credit Agricole CIB, it will fall even further this year and cross the psychological mark of seven to the US dollar (RM4.47).

It’s a stunning reversal for a currency that stood out for its resilience at the outbreak of Russia’s war in Ukraine.

In the days following the Feb 24 invasion, the yuan was the only EM exchange rate to avoid a decline, trading at an almost fouryear high against MSCI Inc’s benchmark index.

Global demand for it has increased, with countries such as Russia and Saudi Arabia looking to reduce their reliance on the US dollar, as well as US bond investors looking for new safe havens.

But in the past month, sentiment has reversed. China’s zero-covid policy, a ballooning property crisis and a growth slowdown are fuelling an exodus of foreign capital, even as domestic inflationary expectations surge.

China’s central bank has sought to push back against the depreciation and repeatedly set daily fixes above estimates, but the US dollar’s strength is undermining such defensive tactics.

The data releases scheduled for this week don’t look promising either. They may show declines in China’s foreign reserves and export growth, besides a deceleration in services. A weaker yuan has wider repercussions for EMS, which have endured two years of elevated inflation, jitters over the US Federal Reserve’s monetary tightening and the prospect of recession in key western markets.

The Chinese currency, with its 30% weight in the MSCI EMS Currency Index, is pushing the gauge to its worst year since 2015.

In fact, the offshore yuan’s 120-day rolling correlation with the emerging world hovers near the highest level in two years, underscoring its impact.

Goldman and Societe Generale say the weaker yuan could pull the South Korean won, Taiwanese dollar, Thai baht, Malaysian ringgit and South African rand down with it.

SEB sees the Mexican peso, Hungarian forint, Romanian leu and Turkyish lira as the most vulnerable.

“Trade and financial linkages have significantly strengthened between China and other EMS, prominently over the past decade,” said

Phoenix Kalen, the head of research at Societe Generale.

“These deeply embedded relationships render the situation much more difficult for global EM currencies to decouple from China.”