UBS: Should investors worry about a falling yuan?

Even those with no direct exposure to China have taken an interest in the yuan in recent years. The Chinese government’s currency policy has been scanned for clues as to the outlook for the world’s second-largest economy. When China adjusted its currency regime in August 2015, permitting a 3% depreciation of USDCNY in just a few days, fears arose that the government was responding to a sharp slowdown in economic growth and acknowledging that capital outflows had become problematic.

Those fears contributed to a 4% fall in global equities that September, and global stocks also declined early last year for the same reasons. After all, China accounted for around one-third of global GDP growth between 2008 and 2015 in purchasing power parity terms.

The yuan looks set to drop further this year. But CIO considers the factors behind this depreciation manageable, so we do not expect it to derail global risk assets. Instead of resulting from a looming economic or banking crisis, the pressure on the yuan stems primarily from an understandable desire for diversification among Chinese companies and investors after decades of impressive economic growth and wealth creation – a desire that generates and exacerbates expectations for further yuan weakness.

For example, Chinese businesses spent a record USD 146bn buying non-financial overseas firms in the first 10 months of last year, according to Commerce Ministry data, beating the 2015 full-year figure of USD 121 bn. (These outflows far exceed foreign demand for Chinese assets that is only gradually increasing due to government efforts to internationalize equity and bond markets.) And while slower economic growth will also weigh on the yuan, the deceleration is likely to be gradual, with GDP expanding by 6.4% this year fromlast year’s 6.7%.

Better communication from Chinese policymakers has further reduced the threat of an adverse market reaction to moderate currency moves. The authorities appeared to have learned their lesson from the anxiety caused by August 2015’s abrupt policy shift. Since then the fall in the yuan has been better managed. The People’s Bank of China (PBoC) has intervened to prevent rapid slides, reassuring investors of its opposition to a sharp depreciation.

This year the PBoC has expanded the basket of currencies it uses as a reference point for the yuan. The move reminds investors that its policy focus is on a broad index rather than solely against the US dollar, which now accounts for only 22.4% of the basket.

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