Yuan bears say this month’s rally shouldn’t be taken as a sign China’s great reversal in capital flows has finished. Goldman Sachs Group warns that any further shock depreciation will only accelerate the exit.
Daiwa Capital Markets, which predicted the outflow risks back in 2014, says less than half of the $3tn of dollar debt that ended up in China has been repaid. Commerzbank said record new yuan loans in January showed companies are raising money to repay more debt abroad.
Corporate bond sales onshore have more than doubled this year, as offshore issuance in the greenback dropped about 30%. Goldman Sachs says there have been $550bn of outflows in the second half of 2015, and that every 1% yuan weakening risks $100bn more.
The yuan’s appreciation in the four years through 2013 prompted companies to borrow dollars offshore and use the money to profit from a strong currency and higher interest rates in China.
The one-way bets began to fade in 2014 as the exchange rate to the dollar plunged the most since 1994. This month’s 0.9% rally hasn’t dissuaded analysts from forecasting a further 3.4% drop by year-end.
“We’re less than halfway done” in terms of carry trade unwinding, said Kevin Lai, chief economist for Asia excluding Japan at Daiwa. “My main focus is not about unwinding, but the reverse carry trade. People are taking fresh positions to sell the yuan. We’re talking about a massive deflationary scenario now, which is very bad for the market, economy, for everything.”
Daiwa’s estimate for the carry trade is on the high side because it includes borrowing by companies outside China, such as Hong Kong and Taiwan.
Oversea-Chinese Banking Corp economist Tommy Xie estimates the positions at around $1tn, based on data from the Bank of International Settlements and the Hong Kong Monetary Authority. Chinese companies’ total foreign- currency debt dropped by about $140bn in the second half of 2015 to $1.69tn, including corporate borrowing from onshore banks, Goldman estimates. That was dwarfed by the $370bn outflows by Chinese residents buying foreign currencies, it said.
“A risk is that any further shocks to renminbi confidence and the perception of policy uncertainty could sharply compound the outflow pressure and render any subsequent stabilisation attempts much less effective,” Goldman wrote in a note released to media on January 26.
Outflows from China increased to $1tn last year, according to estimates from Bloomberg Intelligence. That’s more than seven times the amount of cash that left in 2014.
Yuan depreciation expectations will accelerate the exit further this year, a researcher with the State Information Center wrote in the Shanghai Securities News this week, reducing the effectiveness of monetary tools such as cuts in interest rates and bank reserve-requirement ratios.
January’s surge in new credit to a record 3.42tn yuan ($525bn), caused by seasonal factors and a switch into local-currency liabilities from overseas borrowings, risks fuelling bad debt amid the slowest economic growth in a quarter century.
New yuan loans surged to an unprecedented 2.51tn yuan, while onshore bond issuance has reached 2.8tn yuan so far this year. Chinese firms’ dollar note sales dropped annually in 2015 for the first time since 2008 to $220bn as raising funds onshore became cheaper.
Policy makers will guide the yuan lower after keeping it stable for a while, said Song Yu, Beijing-based chief China economist at Goldman Sachs Gao Hua Securities Co.
He estimates the currency will depreciate to 7 against the dollar by the end of this year and to 7.3 by the end of 2017. On an annual basis, the yuan’s Sharpe ratio, which measures returns adjusted for price swings to gauge its carry trade appeal, was the highest in the region in 2011-2013 before turning negative.