Why the yuan’s fall mat­ters to us

The China Post - - COMMENTARY - BY GOH ENG YEOW

With the media fix­ated on Sin­ga­pore’s up­com­ing gen­eral elec­tion, few peo­ple out­side the fi­nan­cial mar­kets have paid much heed to main­land China’s re­cent move to ditch its “soft” peg to the U.S. dol­lar.

But the blood­let­ting in the Straits Times In­dex (STI) and other widely watched re­gional barom­e­ters such as Hong Kong’s Hang Seng In­dex sug­gests that this de­vel­op­ment de­serves closer at­ten­tion from all.

Since Jan­uary, the STI has fallen by 11.7 per­cent in Sin­ga­pore dol­lar terms and 16.8 per­cent in U.S. dol­lar terms.

Half of the losses oc­curred in the past fort­night.

Main­land China’s cur­rency has tracked the U.S. dol­lar for as long as any­one can re­mem­ber, so its de­ci­sion to end the U.S. dol­lar peg at a time when the re­gion is faced with grow­ing eco­nomic un­cer­tain­ties and plung­ing com­modi­ties prices is viewed with anx­i­ety by in­vestors.

Try­ing to work out the im­pli­ca­tions of China’s move is com­pli­cated by the fact that observers are not ex­actly sure what prompted it, or what is likely to hap­pen next.

True, China had been keen to sell the idea that this step was taken to en­able it to present the yuan as a mar­ket-driven cur­rency wor­thy of a place along­side the U.S. dol­lar, yen, euro and ster­ling, and to be named as a re­serve cur­rency by the In­ter­na­tional Mon­e­tary Fund.

Then there is the ar­gu­ment that if China is re­ally se­ri­ous about de­valu­ing its cur­rency to help the na­tion’s ex­porters, it would have gone for a much big­ger drop, rather than the 2.8 per­cent fall which the yuan has so far reg­is­tered against the green­back.

But the move took place against the back­drop of an eye-pop­ping 8 per­cent drop in China’s ex­ports last month from the same pe­riod last year.

This seems to con­firm the bear­ish view that the Chi­nese econ­omy may be in a worse shape than pre­vi­ously thought.

Af­ter all, Bei­jing has tried a host of mea­sures in re­cent months to spur the econ­omy, from cut­ting in­ter­est rates to low­er­ing re­serve re­quire­ments — the sum which main­land Chi­nese banks must set aside for a rainy day — and talk­ing up its stock mar­ket be­fore it suf­fered an ig­no­min­ious col­lapse last month.

So while chang­ing the yuan’s daily ref­er­ence price from an of­fi­cial fixed level to the end­ing price of the pre­vi­ous trad­ing ses­sion may seem in­nocu­ous, some mar­ket pun­dits view it as a nat­u­ral pro­gres­sion of the mea­sures that China is tak­ing to re­vive its slow­ing econ­omy.

Still, one ques­tion is why should in­vestors even care about a slide in the yuan against the U.S. dol­lar.

Af­ter all, one can ar­gue that the yuan is only play­ing catch-up with other ma­jor re­gional cur­ren­cies, such as the Ja­panese yen and the Aus­tralian dol­lar, which have plum­meted by a much big­ger mar­gin. Even the Sin­ga­pore dol­lar has lost 6.5 per­cent against the green­back since Jan­uary.

But China is not just any other coun­try. It is a US$10 tril­lion econ­omy and any ac­tion it takes on its mon­e­tary pol­icy af­fects the world.

Dur­ing the Asian fi­nan­cial cri­sis 17 years ago, as one des­per­ate Asian coun­try af­ter another de­val­ued their cur­ren­cies, China won wide­spread ku­dos for halt­ing the malaise by keep­ing the yuan firmly pegged to the U.S. dol­lar.

Seven years ago, when the world was en­gulfed in another huge fi­nan­cial firestorm, China again fixed the yuan to the U.S. dol­lar and launched a 4 tril­lion yuan (US$629.4 bil­lion) stim­u­lus pack­age that whet­ted de­mand for ev­ery­thing from Aus­tralian coal to U.S. cars.

Sit­ting on top of a huge US$3.7 tril­lion of for­eign re­serves, it should have been in a po­si­tion to en­force any given for­eign ex­change rate that it wants to have.

So aban­don­ing the peg can only mean that even China is find­ing it too costly to keep the yuan shad­ow­ing the resur­gent green­back, which has been bol­stered by fall­ing energy prices, a re­viv­ing United States econ­omy and the prospect of a hike in in­ter­est rates. The fall­out has been im­me­di­ate. Mer­rill Lynch’s latest fund man­ager sur­vey shows in­sti­tu­tional in­vestors have turned cagey about emerg­ing mar­kets, nam­ing “China re­ces­sion” risk as the big­gest prob­lem on the hori­zon.

They are also wor­ried about com­modi­ties-rich coun­tries which are closely linked to China’s busi­ness cy­cle, as well as mar­kets such as South Korea and Tai­wan which have ex­po­sure to China through their non-com­mod­ity ex­ports.

The re­sult is a rout in re­gional stock mar­kets and a wob­ble in com­modi­ties- de­pen­dent cur­ren­cies such as the Malaysian ring­git and the In­done­sian ru­piah, both of which have fallen to their low­est lev­els against the U.S. dol­lar since the depths of the Asian fi­nan­cial cri­sis in 1998.

For us, how­ever, it is the po­ten­tial fall­out on the in­ter­est rates front that we have to be wary of, since many of us are sad­dled with huge mort­gages on our homes.

Dur­ing the Asian fi­nan­cial cri­sis, banks here jacked mort­gage rates to as high as 7 per­cent, even though Sin­ga­pore was a rel­a­tive oa­sis of sta­bil­ity amid the fi­nan­cial tur­moil in the re­gion, as the Thai baht and the ru­piah plum­meted.

No doubt, in­vestors have re­sponded to China’s cur­rency in­ter­ven­tion by mark­ing down their ex­pec­ta­tions of a rise in U.S. in­ter­est rates next month.

This should of­fer re­lief to home­own­ers fear­ful of an in­ter­est rate hike here, since Sin­ga­pore in­ter­est rates track the U.S. mar­ket closely.

But as re­gional cur­ren­cies weaken in the wake of Bei­jing’s so-called de­val­u­a­tion move, this is also caus­ing the Sin­ga­pore dol­lar to wob­ble and in­vestors may de­mand a higher in­ter­est rate as com­pen­sa­tion for hold­ing a weaker cur­rency.

Since Jan­uary, the three-month Sin­ga­pore in­ter­bank of­fered rate (Si­bor), which is used to set in­ter­est rates for mort­gages, has more than dou­bled to 0.93825 per­cent.

Chances are that even with­out a U.S. in­ter­est rate hike, Si­bor will face fur­ther up­ward pres­sure if re­gional cur­ren­cies con­tinue to plum­met.

Of course, this may just be a case of sea­sonal volatil­ity.

But it looks like we are in for a bumpy jour­ney with Si­bor as re­gional cur­ren­cies go on a roller­coaster ride.

Home­own­ers with big mort­gages should pay at­ten­tion to what the fi­nan­cial mar­kets are telling them.

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