By John Richardson
LAST year nearly $1trn was moved out of China as rich people lost confidence in the direction of the economy. Much of this was moved if not illegally, then through stretching the rules to the very edge of snapping point.
Take the practice of Smurfing as an example. The New York Times describes this as follows:
Individuals are asking friends or family members to [physically] carry or [electronically] transfer out pf China the annual legal limit of $50,000. A group of 100 people can, as a result, move $5m overseas. Chinese customs officials caught a woman last year trying to leave the mainland with $250,000 strapped to her chest and thighs and hidden inside her shoes.
Beijing is thus once again engaging in its “whack-a-mole” game to close loopholes, which also include huge over-invoicing of imports from Hong Kong. The idea here is that you pay way too much for these imports, and so are able to move money offshore.
Zhou Xiaochuan, the chairman of the People’s Bank of China, China’s central bank, stepped in at the weekend in an effort to calm speculation that capital flight, and slower GDP growth, would force China into a major competitive devaluation of the Yuan.
Such a devaluation would be an alternative of further depleting foreign currency reserves that have fallen by $420bn over the last six months to their lowest level in three years. In the face of this capital flight, the reserves have been sold off to prop-up the value of the Yuan against the US dollar.
There is also a long-standing concern, which I first raised in 2013, that weaker GDP growth might also force China into a competitive devaluation. It has vast manufacturing surpluses, and some big surpluses in chemicals and polymers to get rid of.
Even without a big drop in the value of the Yuan it is also already exporting some of these surpluses. For instance, look at the recent surge in purified terephthalic acid exports. Just imagine, therefore, how much deflation China might export to the rest of the world if it opted for a big devaluation.
The chances of a big devaluation will increase if the current fad for negative interest rates amongst developed world central banks continues.
This all means that despite Zhou’s calming words at the weekend, some analysts still think there is a pretty high probability of a big devaluation of the Yuan before the end of this year. Societe General, for instance, attaches a one in three chance of a 13% fall in the Yuan by the end of this year. One hedge fund, which understandably has a strong motive here, believes that the Yuan could fall by as much as 30% in value.
You are a chemicals company planner. What do you do with all this noise? How do you make sense of it?
Build a “worst case” scenario where China is forced into a big competitive devaluation by the end of the year and model what this would mean for your business.
Vulnerable products include not just PTA, but also propylene and its derivatives phenol and acetic acid where oversupply is significant. You can also add to this list polyvinyl chloride and polyethylene terephthalate, which have been very long in China for several years. Even in polypropylene three was a big increase in exports in 2015 from a very low base as China moved aggressively towards self-sufficiency.
You must also, of course, model what a big devaluation would mean for your local downstream customers, as China would be able to more effectively export say plastic film or auto components.
How do you monitor the probability of this worst case scenario? Here are three things to keep your eye on, along with some context:
- The rate at which China keeps burning through these reserves. It is a fallacy to look at these reserves and think that because they still stand at $3.23tn – the biggest reserves in the world – China can afford to let them deplete a great deal more. This ignores the fact that some of the reserves are illiquid, and that in total these reserves are less than the debts built-up during the 2008-2013 economic stimulus programme. China thus needs to preserve these reserves. A big currency devaluation might therefore be a less painful option than allowing these reserves to continue to fall at recent rates.
- The pace of capital flight. This will depend on how effectively China plays its latest round of its “whack-a-mole” game. It seems likely that as each loophole is closed, another will be sought. The pace of this flight will also hinge on confidence in the economy – i.e. the effectiveness of the reform programme.
- The policies of central banks in the developed world. I cannot stress enough the risk from negative interest rates. If these spread and deepen then China, and other major exporting countries, could be pushed into a corner. We might end up with a round of very damaging “tit for tat” currency depreciations
How does China get itself out of this jam? It is by sticking to the boldest, most risky set of economic reforms that it has attempted for at least 20 years.
If these reforms are successful than hurdles such as the “middle income trap” and very serious environmental problems will be cleared.
Then the money flows will reverse as local people bring their money back, and as foreign investment takes advantage of the new tremendous new growth opportunities that will be centred on affordability and sustainability.