Morning Brief – Sticky CNY

Sticky CNY

Uncertainty and risk continue to pervade and detract investors from Chinese stocks. In particular, investors continue to question whether the crisis within Chinese real-estate stocks will be contained within the sector or spread through the financial sector, deteriorating financing and economic conditions nationwide. Whilst stocks in the one of the world’s most indebted companies, Evergrande, which provided the spark for wider industry contagion have been suspended pending the announcement of a potential cash-raising sale, similar companies have grabbed headlines citing similar financial perils.

The Chinese government and central bank have so far both still failed to directly address the risks and unfolding crisis associated with property giant Evergrande. The government has reportedly conducted communications with Chinese state-controlled companies urging them to buy assets and provide fair bids and cash to the imperilled company. The risks to investors and the Chinese public therefore still remain very real, with daily public demonstrations by those who have equity tied up within housing projects undertaken at the failing company standing as testimony to the public risk associated with default.

Property development has been one of the main drivers of high single, even double, digit growth in China for decades. The highly leveraged building projects have proven to be the backbone of Chinese growth and allowed the governing CPC to hit its lofty growth targets. The failure of these companies is expected to put an end to the Chinese growth model and in turn is putting immense pressures on growth in the nation. In the face of such uncertainty with respect to growth, the question now is why has the Chinese Yuan proved so stable?

When questioning Yuan stability the question of the People’s Bank of China’s (PBOC’s) control over the currency is always a good starting point. Whilst no longer electing for a direct peg to any currency, the PBOC does publish a reference rate each trading day within which the open market is free to trade around within a narrow band of tolerance (2%). By retaining the ability to set the reference rate, the PBOC can influence the level at which the Yuan trades. There has been a changing tone at the PBOC and indeed within the CPC with a focus on the stable provision of energy amidst rising energy prices globally taking centre stage of policy. There has therefore been a tolerance for stronger CNY pricing when setting daily reference rates to assist this aim. This is because a stronger Yuan will limit the import costs of foreign-currency-denominated units of energy traded globally.

The side-lining of the Evergrande saga at the national and central bank level with a preference towards focussing upon the robust underlying economy has helped soothe nerves in the FX market. The early tightening cycle that the PBOC undertook to correct Covid-19 crisis-era policy has also been supportive of the currency.

Discussion and Analysis by Charles Porter

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