Default risks among companies in the People’s Republic are rising as the regime struggles to keep the yuan’s exchange market slide gradual. The authorities have taken a number of steps to slow the unit’s depreciation. They have issued new rules clamping down on overseas investments by Chinese companies. They have instructed banks to limit sharply how much companies, be they Chinese or foreign, may move out of the country into other operations they have around the world. The have also used “moral suasion” to prevent money from leaving, urging people not to “blindly follow the crowd” in converting yuan to foreign currency. None of this has made much of a dent into the hemorrhage of capital that the country has been experiencing, a massive net outflow through both hot money and FDI pipelines that totaled USD 530 billion in the first ten months of last year and nearly USD 70 billion in November.
The reasons for the exodus are varied, but at least in part include the relative softness of the economy. Growth appears to have steadied in November, judging from industrial output, investment and retail sales reports, and may have reached the official target of 6.5%-7.0% for all of 2016. Chinese statistics being what they are, however, this is not saying much, the less so as it took a flood of money from the Central Bank for lending and massive government spending on infrastructure to reach the marker. Room for further stimulus is now quite limited, on the monetary as well as the fiscal side. Overcapacity in many sectors is putting downward pressure on the prices companies can charge. Wages keep rising and even among better-managed entities profits are stagnant. Many state firms are losing money. Beijing has already started to snug up its monetary policy in response to growing worries about asset bubbles and rising corporate debt levels. It will probably have to get tougher on this score, now that the US Federal Reserve has opted for higher interest rates. If so, this will further hinder economic growth without halting the capital flight, which is being fueled – in addition to slack economic activity, the pile-up of company debt, and the recurring asset price bubbles – by President Xi Jinping’s anti-corruption drive.
China’s corporate debt mountain now stands at over 250% of gross domestic product (it was 125% as recently as in 2008) and more & more enterprises are relying on the short-term money market to raise the finance needed to service their obligations. So, even minor increases in short-term interest rates will squeeze corporate activity and precipitate defaults. Against this backdrop, the global strength of the US dollar and the slow, grinding depreciation of the yuan give companies and individuals one more reason to move money out of the country. Granted, against a trade-weighted set of currencies the renminbi’s slide has not been overly dramatic so far, but most people focus on the dollar exchange rate and this is close to an eight-year low, down about 13% from its peak in January.
No Good Options
It is difficult to see what the authorities should, or could, do under these circumstances. Some in Beijing suggest a large, formal one-shot devaluation or even a free float to reset the exchange rate at a level that is generally viewed as cheap. But such a policy would be fraught with grave risks. It would deal a devastating blow to the countless companies and banks with hefty dollar-denominated obligations on their shoulders, debts that would become much more difficult to service and could trigger a rash of defaults. It would cripple importers and local entities dependent on imported materials and parts. Since no one knows for sure at what level investors would feel reassured about the yuan’s valuation, moreover, a big debasement could easily over- or undershoot and threaten the whole country’s financial stability. It would also be politically explosive, considering US President-Elect Donald Trump’s often reiterated threats to label China a “currency manipulator” to be countered with punitive tariffs.
This would seem to leave as the only viable option continued Central Bank intervention to prop up the currency. Such intervention does not come cheap. The CB has been burning through hard-currency reserves on a huge scale. But even after a November drop by USD 69.1 billion these assets still stood at a whopping USD 3.051 trillion, so the CB has plenty of fire power left. On the negative side, expectations of continued renminbi depreciation against the dollar and concerns about the cloudy outlook for the Chinese economy are undermining demand for the currency and global use of the yuan is now shrinking, only a year after Beijing, in its internationalization drive, achieved its goal of having it admitted to the IMF’s reserve currency basket. The ultimate aim has been to make the renminbi a rival for the US dollar. This campaign, which has all along looked like a long-shot proposition, has now been set back in a major way.