A Hard Landing or Soft Descent? What the Chinese Can Do to Save the Day, and What They Cannot

According to Ministry of Commerce of the Peoples Republic of China, last year, actual foreign direct investment surged by 7.9%. The report on the last half of 2015 is still not available for unknown reasons. Mind you, the missing part of 2015 might be very alarming as there can be seen a direct correlation between currency rate decrease and FDI in the last 2 years.

Meanwhile, Shanghai Stock Exchange Composite Index’s YTD return is as low as -21.92%. A return this low may seem to be a salient piece of news in itself, but it pales in insignificance when you look at the greater picture. While not being at its lowest, it has had a very strong trend during last half year. In the last year alone the volatility of the index broke all bounds. This generally steady index during the 2010s doubled in 4 months and then backed down to the same level in the next 6 months. This sparks understandable doubt among investors because the 5th biggest index in the world cannot be traded carelessly with this kind of uncertainty for the future.

Since the end of 2013, when CNY hit its high at 6.04 vis-a-vis USD, it has dropped to 6.56. This heavy trend of depreciation is relatively controlled by the Chinese government. In the last 3 months in particular, the Chinese have actively burned federal reserves. China’s Foreign Exchange Reserves have decreased by 5.6%, thus saying that Chinese are already controlling the depreciation of yuan. The reason why depreciation must be so tightly controlled is that if it comes close or exceeds inflation, then bonds and other types of investments become more unappealing and riskier to investors. Hence, by keeping the rate steady, the Chinese can boost their export and simultaneously manage to sustain a steady FDI increase.

Chinese yuan is already depreciating at a steady, government-controlled pace. As China cannot keep burning reserves for much longer at this pace (they can afford to do so, but this might bring about even more dire consequences), there remain only two options: to impose new capital controls, or to devalue yuan. The Chinese government recently introduced new, further capital controls which allow only 50K USD as the annual limit companies or individuals can trade for yuan without any documentation proving further purposes to invest. These already heavy controls leave no much space of stepping them up even further. Also, the government has already markedly devalued yuan during the past year.

The trend can be sensed right away. The shift towards more “public” China has started. The Communist party is controlling the change, shunning no reasonable measures that there are. As China has for long been very stagnant and motionless in terms of politic and economic innovation, the fact that it is changing is a very encouraging piece of news for both investors and the Chinese themselves.

By Nils Vanags
Market Analyst at the Investment Fund