With the International Monetary Fund currently deliberating over whether to add the yuan to its special drawing rights currency basket, one would think that the last thing China needs is to see renminbi depreciation.
However, there is also the alarming prospect of stalling Chinese economic growth to contend with, leading Seager-Scott, director of investment strategy, to predict that a period of Chinese quantitative easing is becoming increasingly unavoidable.
“China seems to have very few options left to regain its competitiveness and foster much-needed growth,” he explained. “We therefore see a strong possibility that the Chinese authorities will look to devalue the yuan over the next 12 to 24 months.
“The decision by the IMF on including the yuan in the SDR currency basket may influence the timing of any devaluation, but we suspect the compulsion to kick-start manufacturing export competitiveness will ultimately prove irresistible.”
In June, the yuan’s real effective exchange rate stood at 140 when rebased to 2005, compared to the euro and yen being at roughly 95 and 77 respectively.
Based on this, Seager-Scott believes that the currency trading almost 40% more expensively on a relative basis than its major export rivals puts China in an awkward position, and could eventually lead to the global recovery being knocked off kilter.
“Clearly devaluation will be negative to domestic Chinese assets in the short-term,” he said. “However, of more concern is the potential wave of deflation that could emanate out across markets from the world’s second largest economy.
“Given how low inflation levels currently are, this could damage the global economic recovery by weakening consumer demand and increasing the real debt burden. Yuan devaluation could also further weaken US profitability by pushing the dollar even higher and leaving the US as the main loser in what amounts to a fresh currency war.”
Given this ominous forward view Tilney Bestinvest is currently underweight China, with its only exposure coming through funds with minimal yuan-denominated investments, such as First State Asia Pacific Leaders and JPM Emerging Markets, which carry Chinese equity weightings of 2% and 15.3% respectively.
“We recently took the decision to move incrementally towards a more cautious stance by marginally increasing our cash and absolute return exposures by decreasing fixed income overall to underweight and our equity exposure to neutral,” said Seager-Scott, referring to Tilney’s overall Asia exposure.
“This in part reflects an increased risk of China-led instability, though we note there are still a number of positives for equities, particularly in those regions that are engaged in QE-like programmes.”
