As economic tides are shifting, it is time for Chinese companies to be cautious with foreign debt.
Last week, the dollar extended its rise. Against a broad basket of currencies, the dollar is now trading at a four-year peak.
Despite these gains, international uncertainty has caused volatility in U.S. stocks, while Treasuries have rallied.
After borrowing billions of dollars from the U.S., Hong Kong and elsewhere, several Chinese companies have reported hits to their financial results from foreign-currency exchange rates.
In the first half of 2014, the dollar rose against yuan to $6.24. Currently, it is at around $6.13. While weaker Chinese currency makes Chinese exports cheaper abroad, it makes paying interest on foreign – particularly dollar-denominated – debt more expensive.
Fed’s monetary shift
In the United States, economic indicators for the 2nd half of the year tell a story of recovery and the outlook for 2015 is seen at 2.5-3 percent.
With improving economic conditions, the debate has begun when the rate hikes should follow.
For three decades – until 2008 – when the Fed wanted to boost total spending in the economy, it reduced the federal funds target. When it wanted to curb spending and reduce inflation, it raised the federal funds target.
Then came the global financial crisis and three-decade old rules were changed in weeks.
Under Ben Bernanke, the Fed reduced the federal funds rate to 0-0.25% in fall 2008. When that proved inadequate, Bernanke turned to non-standard monetary instruments increasing the Fed’s balance sheet from $0.9 trillion to $4 trillion between 2007 and 2013.
Today, the policy rate hikes are expected by the second-quarter of mid-2015 – possibly even earlier.
China’s long landing
In China, the challenge of Premier Li Keqiang has been to manage the housing market volatility, while continuing deleveraging in the local government. It is a precarious balancing act.
If deleveraging moves ahead too aggressively, housing sales will suffer. Conversely, if deleveraging is too slow, it would continue to boost housing markets artificially, which could give rise to new bubbles.
For months, President Xi Jinping has said that China must adapt to a “new normal.” In the short-term, the new era for China’s economy means slower growth, painful restructuring and conflicting responses from the market in digesting government stimulus.
In 2014, real GDP growth will be around 7.2-7.5% in annual terms and could remain around 5.5-6.5% through the rest of the 2010s.
Since major policy easing – read: a “big stimulus” – is not likely, some 9.8 million urban jobs have already been created, the annual target of 10 million will be easily reached before the year-end.
Despite a lot of anxiety domestically and far more internationally, China has begun its long landing. Structurally, that means transformation to a post-industrial economy.
Toward volatile currency markets
The U.S. jobless rate has fallen to 6.2 percent, while inflation remains less than 2 percent. Nevertheless, any premature rate hike could cause new economic uncertainty and market volatility.
As the value of the dollar is rising and the Federal Reserve is preparing to hike the rates, dollar-denominated foreign debt is no longer cheap. A stronger dollar is causing currency instability in emerging markets.
In China, Chinese energy producers and airlines have long been vulnerable to currency fluctuations because the global oil market conducts business in dollars.
Recently, the impact has been broadened by the yuan’s prolonged slump, which is affected by deleveraging –which, in turn, makes borrowing more difficult and reinforces unease in the property markets.
Where China hopes to tame inflation, overcapacity and short-term speculation, U.S. addiction to debt continues to prevail – evidently until the next crisis.
Over the longer term, China will allow the yuan to resume its rise against the dollar. In the shorter-term, managing the risks from the yuan-dollar exchange will be challenging.
The original version was released by Shanghai Daily (Oct 17, 2014)