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China is no Japan

The Chinese yuan has broken through the 6.0 per dollar trading band, weakening from 6.02 to 6.12 in a month. Such is the fragility of sentiment towards China that this 2% fall could be mistaken for a collapse, but it’s only a temporary reversal. We don’t think portfolios exposed to China are about to incur large currency losses.

Since mid-January, the People’s Bank of China (PBOC) has added liquidity to money markets, pushed down interest rates and set the central exchange rate against the dollar progressively lower. This is partly to add some two-way risk into markets after a period of almost straight-line currency gains. Also, highly publicised concerns over trust fund redemptions and softening growth have prompted a slightly looser monetary policy.

Beijing’s currency policy has consistently favoured appreciation since the “managed float” of the yuan, when it was de-linked from the dollar on 21 July 2005. China has occasionally allowed the exchange rate to drop to remind investors that the currency is not a one-way bet. This latest move bears all the hallmarks of another warning.

At the same time, China still runs a massive trade surplus (which means a large inflow of dollars and other foreign currency to pay for Chinese exports) and the country’s stringent capital controls limit the flight of capital out of the country, and thus limit downside risk for the yuan. During the Asian financial crisis of 1997-99 China provided leadership to Asia by refusing to devalue its currency. There is nothing in recent policy statements to suggest it’s any different this time.

In fact, China’s stated aim of transferring its centre of gravity from industry to services requires a stronger currency, not a weaker one. China wants productivity growth and higher international purchasing power for its consumers. A weaker currency would bring the opposite.

Japan’s recovery plans rely on a weaker yen. But China is no Japan.

This was posted in Bdaily's Members' News section by Coutts & Co .