China faces a complex challenge as it aims to further stimulate its economy amidst a relentless property crisis while avoiding the repercussions of a devalued currency. It’s a delicate tightrope walk that could see the nation persistently offloading US bonds and equities.
The Chinese government is poised to inject an additional one trillion yuan into its faltering economy. The persistent property sector woes show no signs of abating and are now seeping into banking, construction, and retail.
This stimulus pushes the central government’s budget deficit to 3.8 percent of GDP, breaching the commonly accepted ceiling of 3 percent. Local governments, deprived of revenues from land sales, are incurring substantial debt to survive. Factoring in these local deficits, China’s budget shortfall soars past 7 percent—surpassing those of the US and Eurozone.
Xi’s PBoC visit
President Xi Jinping’s unprecedented visit to the People’s Bank of China (PBoC) on 24 October was likely more than ceremonial. It underscores heightened expectations for the PBoC to reduce interest rates or the Required Reserve Ratio further, despite the potential risk to the Chinese yuan, which has already slid nearly 10 percent since mid-January.
Currency maneuvers
In an effort to stabilize the yuan, the PBoC has been setting its reference rate significantly higher than market levels, signaling discomfort at a USD-CNY exchange rate above 7.30. Simultaneously, bets against the yuan have been made less appealing through increased costs.
Monetary easing seems inevitable to bolster fiscal measures, aligning with the central leadership’s direction. Yet, such actions will compel the PBoC to intensify its efforts to uphold the yuan’s value above the crucial threshold of 7.30, necessitating continued sales of US dollars for support.
Divesting from US assets
The accompanying graph highlights China’s net sales of US Treasuries and equities, with a pronounced trend of divestment. These sales are often linked to US-China political tensions and the wider narrative of deglobalization. However, the economic imperative behind the sales, particularly of equities, is notable.
Global equity implications
While it’s conceivable China may choose not to shield the yuan against further decline—a strategy recently observed in Japan’s market interventions—a depreciating yuan could spell trouble for global equity markets.
Jeroen Blokland is the founder of True Insights, providing independent multi-asset portfolio research. Formerly leading multi-assets at Robeco, Blokland’s «Chart of the Week» features on Investment Officer Luxembourg every Monday.