China’s currency struggles create problems in emerging markets
Bloomberg’s Most Read
Just a few months ago, the Chinese yuan reigned supreme as an emerging market safe-haven asset, shielding investors from the turbulence of war and runaway inflation.
Today, it becomes a threat.
As growth slumps in the world‘s second-largest economy, its currency has fallen to its lowest level in two years and looks poised for further losses. This pushes Goldman Sachs Group Inc. at SEB AB to predict shock waves not only in the neighborhood of China, but as far as Africa and Latin America – with a cheaper yuan attracting exports from others country and triggers competitive devaluations.
“With the yuan expected to weaken further, other emerging markets will see downward pressure on their currencies,” said Per Hammarlund, chief emerging markets strategist at Skandinaviska Enskilda Banken AB. “The impact will be felt most by countries that directly compete with China on exports.”
The yuan fell for a sixth consecutive month in August, capping the longest losing streak since the climax of the US-led trade war in October 2018. It will fall further and break through the psychological barrier of 7 to the dollar this year, banks including Société Generale SA, Nomura Holdings Inc. and Bank of America Corp. say.
It’s a stunning reversal for a currency that stood out for its resilience at the start of the Russian war in Ukraine. In the days following the February 24 invasion, the yuan was the only emerging market exchange rate to avoid a decline, trading at a nearly four-year high against the MSCI benchmark. Inc. Global demand for it has intensified – from countries like Russia and Saudi Arabia seeking to reduce their reliance on the dollar to US bond investors seeking new safe havens.
But over the past month, the sentiment has reversed. China’s Zero Covid policy, burgeoning real estate crisis and slowing growth are fueling an outflow of foreign capital, even as domestic inflation expectations rise. China’s central bank sought to push back the depreciation. It has pegged the yuan fixation higher than expected for the ninth straight session, but dollar strength is undermining those defensive tactics.
The data releases scheduled for this week don’t look promising either. They may show a decline in China’s foreign exchange reserves and export growth, in addition to a deceleration in services.
A weaker yuan has broader repercussions for emerging markets, which have endured two years of high inflation, jitters over Federal Reserve monetary tightening and the prospect of a recession in major Western markets. The Chinese currency, with its 30% weighting in the MSCI Emerging Markets Currency Index, pushes the gauge to the worst year since 2015. In fact, the offshore yuan’s 120-day rolling correlation with the emerging world sits near the highest high level in two years, highlighting its impact.
Goldman and Societe Generale say the weak yuan could drag the South Korean won, Taiwanese dollar, Thai baht, Malaysian ringgit and South African rand lower. SEB sees the Mexican peso, Hungarian forint, Romanian leu and Turkish lira as the most vulnerable.
“Trade and financial ties have strengthened significantly between China and other emerging markets, prominently over the past decade,” said Phoenix Kalen, head of research at Societe Generale. “These deep-seated relationships make it much more difficult for global emerging market currencies to decouple from China.”
What to watch this week:
China to release data for August that could show falling foreign exchange reserves, slowing exports and weaker inflation printing at factory gates
Data may show government stimulus helped fuel a rebound in credit
Growth in China’s services activity held steady in August and expanded for a third straight month, a private survey showed Monday
Central banks in Malaysia, Poland, Chile and Peru expected to raise interest rates
Turkey, Hungary, Thailand, Philippines, Mexico and Colombia expected to release inflation figures
(Updates with the growth of services activity in China in the “What to watch this week” section)
Bloomberg Businessweek’s Most Read
©2022 Bloomberg LP