The People’s Bank of China (PBOC) shocked the financial markets in August as it devalued the currency by lowering its daily mid-point trading price equivalent to a 1.87 percent devaluation against the US dollar – triggering the yuan’s biggest one-day drop in 20 years.
The action loosened the yuan’s link to the value of the US dollar, and allowed a more market-based determination to form a new currency regime.
Helena Chen, partner at London-headquartered law firm Pinsent Masons, said: “To compare with the more persistent and significant yuan appreciations since 2004, this depreciation is still relatively small, and the quantitative impact of the exchange rate move is not likely to be big either, unless it is the beginning of a larger and more persistent period of depreciation.”
The CNY/USD exchange rate was set at around 0.121 in 2004. It has been on an upward track for a decade and reached its record high at 0.1655 in January 2014. Last month, the rate hovered at around 0.157, which is a 30 percent appreciation against the US dollar since 2004.
With regard to the infrastructure space, Chen commented: “Infrastructure could be one of the areas most affected by the devaluation. Foreign investors bringing capital into mainland China to invest in projects will find that their dollars go further and, if the depreciation continues, this will be amplified.”
“Equally, outbound investment will become more expensive, but we may also see capital fleeing the country more quickly, as investors relocate to where the currency is more stable in order to preserve the value of their assets,” noted Chen. “If the market expects further depreciation, this may speed up Chinese overseas investment, especially from the private sectors, to foreign countries.”
In the contractor space, Chen said that there is little reason for concern at the moment.
“So far contractors will not be too concerned about the currency fluctuations, especially if they are state-owned enterprises, since their overseas investment will be aligned with government policy. If they had been taking action that will cause further depreciation, such as purchasing foreign currency, they are likely to discontinue this,” Chen pointed out.
She believed the depreciation so far would have a limited effect on China’s growth slow-down because its roots are structural, including a shrinking labour force and a considerable rise in real wages.
Tai Hui, chief market strategist – Asia at JP Morgan Asset Management, also shared his views on the new exchange rate regime.
He noted that although yuan devaluation may not critically alter long-term investors’ decisions, they should be cautious and consider whether this reflects any structural problems in the Chinese economy.
“Investors are advised to look at those safer areas that provide more room for growth and are supported by government policies, such as the ‘One Belt, One Road’ policy and renewable energy development,” suggested Hui, to those who still want to invest in China.
He believes that, as the PBOC slowly allows the reference rate to adjust based on market forces, currency volatility will increase, which should also mean other Asian currencies becoming more volatile in the longer term.
Hui pointed out that while the possible hike in interest rates by the Federal Reserve tipped for later this year is likely to be modest and manageable, exchange rate volatility will become a much bigger challenge for companies to manage.
In view of this challenge, he suggested investors and asset managers pay extra attention to financing for their projects in the region, and introduce hedges if necessary.
“The currency risk is not imminent but will add difficulty when predicting the future income projection,” he added.