By Carolyn Cui in New York and Lingling Wei in Beijing
The calm in China's currency is making some investors
uneasy.
Twice in the past year, sudden drops in the value of the yuan
have rattled global markets, sparking concerns that a deeper
decline was at hand as officials struggle to orchestrate an
economic "soft landing" following years of debt-fueled growth.
Since then, the People's Bank of China has calmed the waters by
improving communications and the government has increased stimulus
in a bid to stabilize growth. The Federal Reserve's decision to
delay rate increases has kept a lid on the value of the U.S.
dollar, relieving some of the pressure on the yuan.
Yet in a refrain familiar by now to investors the world over,
analysts are worrying that stimulus alone won't be enough to get
China's growth back on track and support the yuan indefinitely.
Fundamental indicators of Chinese economic health continue to
deteriorate, a sign to skeptics that the currency remains
overvalued and a reminder of the challenges facing the world's
second-largest economy.
"China has done a good job in anchoring market expectations and
using all the tools in its policy toolbox to stabilize the economy,
but it hasn't fixed the underlying problems," said David Loevinger,
a managing director at TCW Group, which has $194.6 billion of
assets under management.
Since its devaluation in August 2015, the yuan has depreciated
6.9% against the dollar, less than the British pound and the
Mexican peso. After losing about $800 billion of its foreign
reserves, China has managed recently to slow capital flight.
But the stability came "at the cost of delaying reforms," said
Hung Tran, executive managing director at the Institute of
International Finance. To sustain growth, China has postponed
overhauls of its state-owned enterprises, many of which are plagued
by overcapacity and bad debt.
Private fixed-asset investment in June and July registered
back-to-back monthly declines from year-earlier levels, the first
time that happened since at least 2012.
It's "a sign of business confidence falling, and people worry
that adding more credit is no longer efficient," said Claire
Dissaux, an economist with Millennium Global Investments Ltd.
The retreat reflects in part the costs of China's rapid debt
buildup since the financial crisis.
The country's total debt has climbed to 298% of its gross
domestic product from 274% a year ago, according to the IIF.
Rapidly rising debt tends to be associated with slowing growth, as
risks of capital misallocation and default increase.
Signs abound that consumers and businesses are bracing for
further devaluation. Some Chinese exporters have been hoarding
dollars and keeping their earnings overseas, a move that analysts
say could limit foreign-currency inflows and leave banks short of
funds to lend out.
Outside the country, investors are hesitant to sink money into
Chinese bonds and other yuan-denominated assets despite the
government's efforts to lure foreign capital. Chinese government
bonds boast much higher yields than their Western counterparts.
"Depreciation remains a big worry for a lot of people," said
Larry Hu, China economist at Macquarie Securities, a Sydney-based
investment bank.
In recent months, China's exchange-rate maneuvering has largely
been driven by the dollar. When the greenback is weak, the PBOC
anchors the yuan to the dollar and lets it fall against a broader
group of currencies that includes the euro and the yen as well as
the dollar.
Conversely, when the dollar advances, the central bank lets the
yuan weaken against it while keeping it largely stable against the
basket. This year, the dollar has weakened for longer than it has
strengthened, resulting in a weaker yuan versus the basket than
versus the dollar.
Many within China believe the yuan should be allowed to fall
further as the country's economy slows, but the central bank has
had to take care that such weakening is gradual enough that it
doesn't speed up capital outflows.
Already, there are signs that outflows are accelerating again
amid recent yuan weakening, after having slowed earlier this year.
A net $55 billion left China in July, according to Goldman Sachs
Group Inc., compared with an estimated $49 billion the previous
month.
Beijing's challenge is how to continue letting some air out of
the yuan without triggering excessive outflows and market
instability.
Ms. Dissaux of Millennium Global said she believes the market is
underestimating the risk of yuan depreciation against the dollar.
Investors in the yuan forwards market now expect the yuan to weaken
by 2% over the next 12 months, down from 7% earlier in the
year.
Strategists at Bank of America Merrill Lynch said in a recent
note that the yuan remains vulnerable to renewed capital
flight.
Yet even skeptics agree the timing of any market shift remains
hard to predict.
"The Chinese will do everything in [their] power to maintain
domestic and external stability" in the lead-up to the G-20 summit
in early September and the yuan's accession into the International
Monetary Fund's official basket of reserve currencies in October,
said Eswar Prasad, a former top China hand at the IMF. "It's
unlikely for China itself to be a source of instability at least
for the next three to four months."
The real test will come for China's yuan and its exchange-rate
policy when the market starts to price in more aggressive Fed rate
increases and the dollar resumes its upward march, investors
say.
Senior Chinese officials have repeatedly pledged to keep the
yuan largely stable and not to engage in beggar-thy-neighbor
devaluations -- a statement many say likely will get repeated next
month when leaders from the Group of 20 nations meet in the eastern
Chinese city of Hangzhou for a summit.
"In theory, [yuan] depreciation should benefit exports," a
senior Chinese official said. "But it's not a good idea," in part
because the government has pledged to rebalance the economy away
from export industries and toward consumer-facing businesses.
Any shift in investors' stance toward China is likely to be
deeply felt in financial markets. In a new report, "What Might
Disrupt the 'China Calm,' " UBS Group AG analysts said greater
depreciation pressure on the yuan "may lead to higher global
investor risk aversion."
(END) Dow Jones Newswires
August 28, 2016 13:30 ET (17:30 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.