A: Yes. This is the number one risk. The number two and three risk, shadow banking and local government debt, are intertwined. We have written about how to monetize the situation. But in the end, we believe the risks here are manageable.
Q: Most analysts believe that the RMB will continue to appreciate despite depreciating for around 3% earlier this year. Do you share that view?
A: Yes, the RMB will still continue to appreciate for another two to three years. What’s different now is that it won’t be a one-way bet.
The Chinese currency is determined by one factor: China’s external balance. It is made of current account balance and net capital flows. For the past 25 years, China has always had a net capital inflow. China’s current account surplus will also last for another two or three years. Add these two together, we are still looking at an external balance of over 4% of China’s GDP. That’s a lot of money to support the value of the RMB.
Q: There are more ways for capital to flow out of China now, both official and unofficial. There are times when capital outflow from China became a real concern. Are you concerned about surprises here?
A: No, as China’s capital account won’t be opened too quickly. That’s why I disagree with some forecasters who say China’s capital account will be fully open in 2017 or 2020. Yes, the unofficial channels are getting big, but it’s not getting that big to crash the system. I don’t think even Beijing knows how long it will take to fully open capital accounts.
Q: A hedge fund manager here in Hong Kong said last week that the RMB is likely to continue depreciating, as China needs to devalue its currency to encourage export to maintain growth. Do you buy this argument?
A: That’s textbook logic. But when you apply that to China, it may not be right. We just did some research, and found that the RMB’s exchange rate doesn’t matter that much to China’s exports. When China exports to the U.S. or other markets, less than 5% of the merchandises’ price is explained by the RMB’s exchange rate. The other 95% are explained by other factors such as transport.
You look at the past 25 years until the global financial crisis, China’s export growth has been growing despite the RMB’s appreciation against the U.S. dollar. China’s export market share in the G2 and G3 has held up stably.
Another reason is that China’s net export has been a drag on the economy since 2009 except in 2010. So devaluing the RMB serves some purpose, but it won’t be a policy direction.
Q: Lastly, what are you telling your clients now about how to manage their China portfolio?
A: This is a time to build position and gain exposure to China, because the economy is at a turning point of structural reforms. So it will be positive for the long term. Cyclically, the economic cycle is bottoming out. If the economy is not reacting well to the government’s stimulus measures, there will be policy easing, which again is positive for asset prices.
But I would caution that investors have to be patient. One should not expect to go in and get out within a quarter to make money.
About Chi Lo:
Chi Lo is senior strategist for Greater China at BNP Paribas Investment Partners based in Hong Kong. He joined BNPP IP in 2010 through HFT Investment Management (HK), BNPP IP’s joint venture partner in China, where he was CEO. Prior to HFT, he was head of overseas investment at Ping An of China Asset Management (HK) Ltd. He was also Asia research head at British private property fund Grosvenor, chief economist and strategist for Asia at Standard Chartered Bank and research director for Greater China at HSBC.