There is almost a consensus that the RMB devaluation on Aug 11 was part of China’s policy to gradually lift capital controls so that the RMB could be considered for inclusion into SDRs or special drawing rights, the international currency that includes the USD, Euro, Sterling and Yen. Inclusion as a reserve currency will help to support capital inflows into China at a time when outflows are becoming a concern, lowering the country’s much vaunted foreign exchange reserves.
In a recent report, Citi Research suggests that it’s a Catch-22 situation. Falling reserves is likely to lead to a capital outflow from China as the RMB weakens to its target of RMB6.80 to the USD, leading to further falls in China’s reserves.
Why is this important? Falling reserves throw up a few problems for China in particular. First off, it lowers liquidity in the system and leaves the Chinese government less flexibility to engineer a rebalancing of the economy; it also leaves little room for the government to prop up the stock markets which have been in precipitous fall even before the devaluation. At some point, investors will see a rise in country risk.
Less liquidity means tightening monetary conditions. Economists have long pointed out that the Chinese government has tremendous flexibility to loosen monetary conditions because of its reserves, reportedly of US$3.7 trillion. That flexibility, based on figures cited in the Citi report, may be a fallacy.
Huge outflow, firmer USD
“In the four quarters to June 2015, ‘speculative outflows’ reached $520 billion, considerably more than China has seen in any recent year” notes the Citi report.
Citi cites some alarming figures that indicate demand for USD. Apparently, China’s cross-border debt to banks rose from less than US$200 billion in early 2009 to over US$1 trillion by mid-2014, excluding securities that Chinese firms have issued. According to the Bank of International Settlements, these [debt] securities represents a further US$455 billion.
According to Citi, the US$520 billion outflow figure doesn’t include debt repayments. There is still a stock of foreign exchange liabilities that’s nearly US$1 trillion in size that needs to be repaid, the report states.
The depletion of reserves indicates that the RMB may continue to weaken. If so, “the incentive to remain short dollars erodes” Citi says. The recent devaluation could fuel “further expectations of currency depreciation – our own forecast is for CNY/USD at 6.8 – and this increases the attractiveness of being long-USD” Citi says.
Of course, once a country can print a currency which is internationally accepted, “then its need for precautionary holdings of other countries’ reserve currencies will fall” Citi says. “But our guess is that RMB’s acquisition of reserve currency status will occur more slowly than the liberalisation of China’s capital account.”
The continued loss in Chinese reserves in the short term will be negative for Emerging Market currencies, Citi figures. In a nutshell, the battered regional currencies are not likely to experience any reprieve soon.
By Steve Matthews and William Sim October 30, 2008 04:32 EDT
Oct. 30 (Bloomberg) -- The Federal Reserve agreed to provide $30 billion each to the central banks of Brazil, Mexico, South Korea and Singapore, expanding its effort to unfreeze money markets to emerging nations for the first time.
The Fed set up "liquidity swap facilities with the central banks of these four large systemically important economies'' effective until April 30, the central bank said yesterday in a statement. The arrangements aim "to mitigate the spread of difficulties in obtaining U.S. dollar funding.''
South Korea's benchmark stock index rose by a record, the won surged and the cost of protecting Asia-Pacific bonds from default tumbled on optimism the measures will prevent the global credit crisis from upending financial markets. The Fed and China cut interest rates yesterday, followed by Hong Kong and Taiwan today.
"The swap lines will help unclog the liquidity pipeline and that action is boosting markets even more than'' the Fed's rate cut, said Venkatraman Anantha-Nageswaran, head of research at Bank Julius Baer Co. in Singapore. "It's a step in the right direction and prevents things from getting worse.''
South Korea's Kospi Index surged 12 percent to 1084.72, and the won jumped 14 percent to 1,250 per dollar. Singapore's Straits Times Index climbed 9.7 percent.
The cost of protecting Asia-Pacific bonds from default tumbled, with the Markit iTraxx Asia credit-default swap index of 50 borrowers falling the most since its was created in September 2007.
IMF Credit Lines
The Fed announcement coincided with a decision by the International Monetary Fund to almost double borrowing limits for emerging market countries while waiving demands for economic austerity measures.
The Fed and IMF actions "show international resolve to support strong performing emerging-market economies adversely impacted by the current financial market turbulence,'' U.S. Treasury Secretary Henry Paulson said in a statement.
Emerging-market investors have created "massive demand for dollars and a reduction of liquidity in other currencies'' by going back to investing in the U.S. currency, said David Spegel, head of emerging-market strategy at ING Financial Bank NV in New York.
The Fed swap lines "are designed to help restore liquidity so that a vicious negative spiral doesn't occur,'' he said.
The yield premium on emerging-market dollar bonds over U.S. Treasuries narrowed yesterday by 61 basis points, or 0.61 percentage point, to 7.21 percentage points, according to JPMorgan Chase Co.'s EMBI+ index. The spread has jumped 5.72 percentage points from a record low of 1.49 percentage points in June 2007, and reached its widest since 2002 earlier this month.
"The Fed is there to support large emerging markets that have done their homework over the past several years like South Korea, Brazil, Singapore and Mexico,'' said Alonso Cervera, a Latin America economist with Credit Suisse Group in New York. "These are large, relevant emerging countries that have followed responsible fiscal and monetary policies for the past several years and now are going through tough times.''
The Fed also created this week a $15 billion swap line with its New Zealand counterpart and removed limits this month on four existing swap lines, including one with the European Central Bank. The Fed set up a $10 billion arrangement with Australia's central bank last month and then tripled it to $30 billion.
"The hoped-for result is that we don't see the global financial crisis worsen still more,'' said Lyle Gramley, a former Federal Reserve governor who is now senior economic adviser at Stanford Group Co. "The Fed is making dollars available to the central banks of these countries who are trying to meet the needs of their banking systems.''
The Bank of Korea cut interest rates by a record amount on Oct. 27 and the government pledged to guarantee local banks' debts to help lenders struggling to access foreign funds. Stocks and the won tumbled last week, prompting concern the country may face a currency crisis a decade after the IMF organized a $57 billion bailout to help repay overseas debt.
The swap line with the Fed "will expand our foreign-exchange reserves and help stabilize the currency market," Bank of Korea Governor Lee Seong Tae told reporters in Seoul today. "We'll also try to cooperate with other central banks to stabilize global and local financial markets."
Alan Grayson: "Which foreigners got the Fed's $500,000,000,000?" Bernanke: "I Don't Know." ~ 21 July 2009
Affluent Asians buying dollar bonds abandoned by risk-averse foreign funds
January 29, 2016
HONG KONG (BLOOMBERG) - Asian investors fleeing weakening currencies are filling a gap left in the regional dollar bond market by risk-averse foreign funds.
That's helping to keep a lid on borrowing costs for Asia's investment-grade firms, which are paying lower premiums for international notes than their US peers for the first time in nearly seven years, according to Bank of America Merrill Lynch indexes.
Issuance of bonds that can only be marketed outside the US rose to 52 per cent of last year's US$161 billion sales in Asia from 21.4 per cent in 2010, data compiled by Bloomberg show.
"Demand for Asian credit is supported mostly by the sheer growth of the local investor base," said Sergey Dergachev, a senior money manager who helps oversee about US$13 billion at Union Investment Privatfonds GmbH in Frankfurt. "You have Chinese banks, asset managers, life insurers, private banks who are all flushed with cash and provide a strong bid for upcoming names."
Turbulence in global markets has made familiar local borrowers all the more appealing to Asian creditors. Chinese and other regional investors also have a growing appetite for dollar notes after the yuan devaluation in August triggered currency drops across the region and the Federal Reserve increased interest rates in December. Demand for the securities is getting a further boost as aging populations prepare for retirement, according to Western Asset Management Co.
Funds from Asia bought 88 per cent of Korea Development Bank's US$1 billion 10-year bonds sold earlier in January, up from 73 per cent of its US$750 million 10-year notes issued in September. Asian buyers took 95 per cent of a US$500 million offering from Hong Kong's Swire Properties Ltd this month and 96 per cent of Bank of Communications Co's US$500 million note sale.
Since the third quarter of 2015, a considerable amount of Chinese money has left the country to purchase dollar notes, according to JPMorgan Chase & Co. The nation's foreign currency reserves declined by US$108 billion in December alone, an indication of capital outflows.
"It's a currency view onshore investors take - investors want to invest in US dollar assets," said Ben Sy, the head of fixed income, currencies and commodities at the private banking arm of JPMorgan in Hong Kong. "They would buy the names they know and they trust their own state-owned enterprises."
Bonds from investment-grade firms in Asia outperformed US peers in the past year, returning 1.6 per cent compared with a loss of 2.9 per cent, Bank of America Merrill Lynch indexes show.
While global investors may see Asian credits as risky bets when the US Federal Reserve is raising rates, the demand from regional investors is likely to stay strong, according to Schroder Investment Management Ltd.
"Asian banks have seen an increase in dollar deposits and are comfortable investing in regional credits," Rajeev De Mello, head of Asian fixed income in Singapore at Schroder Investment Management Ltd with assets of about US$446.5 billion under management. "The trend to accumulate dollars will continue as there is still a view that the dollar will strengthen due to the Fed and to Asian central banks being more biased to cut their own rates."