Factors in three aspects have functioned to support a firming Chinese yuan against the US dollar in the wake of  the US interest hike.

Ren Zegang

It was a common view that China would be the biggest casualty of the US interest hike that happened on 14 June as the US Federal Reserve raised the interest rate by 25 basic points to 1-1.25%.

It was expected that decline in value of the Chinese yuan would stimulate more outflow of Chinese capital and force the Chinese authority to increase the interest on yuan in order to prevent the money from fleeing to abroad. Consequently those Chinese businesses and local governments burdened with heavy debts would find it tougher to repay their loan. This in combination with withdraw of capital from the housing market would put huge pressure on the banks and other financial institutions and eventually leading to a financial turmoil.

However none of the pictures painted above have eventuated nearly three weeks after the US interest hike. Instead of declining, the Chinese yuan has firmed and China’s foreign reserve increased thanks to improved export. There is no sign of major irregular movement of money across the border and the interest on yuan has been unchanged.

us yuan month chart

USD vs Chinese yuan

On what basis China has escaped from the disastrous situation widely predicted?

Basically factors in three aspects have functioned to help China.

First, introduction of “counter cyclical factor” 

On May 26, the Chinese authority introduced a “counter cyclical factor” into the method for the calculation of exchange rate of yuan, aiming at stabilizing the currency and reducing its volatility.

Previously the exchange rate of the yuan was allowed to trade in a band two percent above or below the daily midpoint rate which was obtained by factoring against the settlement rate between the yuan and the US dollar as well as a basket of currencies such as euro and Japanese yen.

This system made it relatively easy for speculators to predict the exchange rate of the yuan by referring to the change of value of major currencies in the international markets.

Given pessimistic view on the value of yuan in the past, it became profitable for speculators to short sell yuan when the US dollar as well as other major currencies such as euro and yen is on the rise. Often this resulted in a “herd effects” on selling the yuan making the currency even more unstable.

It was against such a background that the Chinese authority introduced “counter cyclical factor” into the calculation of the exchange rate of yuan. Though this revised methodology is not clearly defined, it is designed to make the process of fixing the daily midpoint less predictable and therefore affect the ability of traders in offshore markets to speculate on the value of the yuan next day.

To lift the overnight interest on yuan to extreme high in the Hong Kong financial market, where the battle of short selling yuan takes place, is another tool the Chinese authority deployed to fight with speculation. On December 30, 2016, the interest on yuan was as high as 66.21%. On Jun 15, one day after the US interest hike, the interest in Hong Kong for overnight yuan was 13%.

Second, tightening Chinese Overseas investment

In 2016, the equity acquisition by Chinese companies in overseas markets recorded USD 225 billion. Many of these transactions carried out by Chinese conglomerates from the private sector. As a major opening for the outflow of Chinese capital, these highly leveraged overseas deals pose risks to the Chinese financial system.

China fdi

The government made response at the end of 2016.  Four government bodies including National Development and Reform Commission, Ministry of Commerce, China’s Central Bank and State Administration of Foreign Exchange jointly lifted bars on offshore direct investment, particularly in areas of real estate, hotel, entertainment business and sport club. Further it was stipulated that Chinese companies were forbidden to invest in foreign entities outside of their main business. For instance, a Chinese manufacturer is not permitted to invest in foreign hotels, sport clubs and etc.

Recently reports fired by Financial Review and other medias of international and Chinese origin revealed that the Chinese government has been investigating five major private companies on their foreign acquisitions, namely Fosun Group,  HNA Group, Anbang Insurance, Wanda Group and Rossoneri.

Some of the deals done by these companies are startling such as Fosun Group’s purchase of football club of Wolverhampton Wanderers with GBP 45 million; the acquisition of Waldorf Astoria hotel which is a landmark in New York city by Anbang Insurance; Taken over of AMC movie Chain in the US and Odeon-UCI and Nordic Cinema group in Europe by Wanda group.

The result of the government’s determined action has been obvious. China’s offshore direct investment reduced by 39% in December 2016 and continuously shrinking at a rate of 30% per month since January 2017. China’s outbound foreign direct investment has retreated 50% so far this year, in accordance with the data released by Ministry of Commerce China.

Third, improvement of the Chinese economy   

Guang Tao, former head of Division of International Transactions, State Administration of Foreign Exchange made a comment that the fundamental factor to the firmness of the Chinese yuan is improvement of the Chinese economy since the later half of 2016.

Electricity consumption, railway freight and bank lending are so called Keqiang index, (named after the current China’s Premier Li Keqiang) considered a better indicator over GDP to the performance of the Chinese economy. Now sale of excavator becomes another popular index for its close relation with infrastructural investment.

In May 2017 the sales of excavator increased by 105% from the level last year. Since August 2016 the sales of excavator has been continuously expanding at rate of 40%.

The railway transportation was stagnated in 2012-2013 and declined in 2014-2015. It has turned around since the second quarter of 2016 and the increase in the first 5 months of 2017 was 13%.

The Chinese real economy is improving. The total profit of secondary industry (manufacturing and mining) has gone up by 22% in the first 5 months of 2017. The Manufacturing Purchase Manager Index was 51.2% in May and has been kept in a positive territory (over 50%) for ten consecutive months.

It should be emphasized that China’s current economic growth is achieved against the backdrop of deleveraging. China’s money supply in May reduced to 9.6% which is the lowest record for a long time. The removal of excessive capacity to the steel and coal industry has achieved 60% and 40% respectively of their yearly target set by the government. Expanding at a rate of 30%, the market share of machinery made in China in international markets have lifted to 17% overtaking that of Germany.

Jun 13, 2017 – The European Central Bank (ECB) completed an investment equivalent to euro 500 million of its foreign reserves in Chinese yuan indicating a trust in the future of the yuan and the Chinese economy. Also IMF revised its prediction on China’s growth from 6.6% to 6.7%.