Ripple effect from a slowing China

Due to the economic headwinds faced by China, the market estimates as to where the yuan is headed will have a significant impact on its traditional trade partners, including Malaysia. — Bloomberg

ONE of the greatest investment thesis for this year, well, at least as far as the start of the year was concerned, was the reopening theme of the Chinese economy that was expected to spur the global economy back to its normalised path, post-Covid-19 pandemic.

That economic thesis was backed by the belief that after nearly three years of on-off lockdown measures, Chinese consumers will be in a revenge spending mode while businesses will boom on this heightened demand, especially in the first quarter of 2023 (1Q23) and going into 2Q23.

Hence, when China announced in 1Q23 that gross domestic product (GDP) expanded by 4.5% year-on-year (y-o-y), beating market expectations of a 4% rise, economists turned bullish on the assumption that the momentum built up post-reopening.

GDP forecasts were raised by not only economists but even by organisations like the World Bank, which raised their target to 5.6% in June from the 4.3% that was made in January this year.

Nevertheless, despite the optimistic view by others, the International Monetary Fund (IMF) maintained its forecast for China’s growth at 5.2% in its latest World Economic Outlook released in July 2023, the same growth level that it had foreseen in January 2023.

It’s falling apart

The first sign of weakness in the Chinese economy was when traditional Asian exporters that are dependent on Chinese importers began to show a deceleration in growth, which has now turned into a double-digit y-o-y contraction for the past few months for selected Asian exporters, including Malaysia.

Being the world’s second-largest economy, China today accounts for approximately 18% of the global economic output, and with its growth rate of more than 5% (based on economist estimates for this year), China accounts for about one-third of the growth of the global economy itself, which is pegged at about 3% by the IMF.

If one takes into consideration the recent global economic forecast made by the World Bank, which is envisaged at just 2.1% for this year, the World Bank’s forecast of China’s GDP growth accounts for almost half of the global economic growth.

With a significant impact on the global economy, recent China’s economic data is indeed a cause for concern.

With aggregate demand slowing in China, the compounding impact of a troubled real estate market is hurting businesses while regional economies have been hit with a slower economic momentum.

A case in point was Malaysia’s slower-than-expected 2Q23 growth of just 2.9% y-o-y, which was well below market expectations, while South Korea and Thailand have recently cut their growth projections for 2023.

Saving grace

With inflation largely absent in China and with the Producer Price Index on a deflationary trend, there is a high possibility that a slowdown in China has some positive impact on the global persistently high inflation prints as Chinese imports get cheaper, both in US dollar terms (as a result of a weaker yuan) and in actual prices due to lower input cost.

However, this may only be realised if producers are passing on the added benefit of a weak currency and input cost to importers of Chinese products.

This is evident from the disinflation rate recorded by most countries, including Malaysia as the headline consumer price index for July only increased by just 2% y-o-y.

The casualty – yuan

With a slowing economy, Beijing is under pressure to jump-start domestic consumption and spur investment.

The troubles of Country Garden and Evergrande have also caused investors jitters as a fallout or failure to restructure the debts of these two property market giants can have a rippling effect on the country’s financial system and markets.

Hence, a recent news report that some of China’s largest banks are preparing to cut rates on both mortgages and deposit rates to shore up economic growth was not entirely unexpected.

This also follows interest rate announcement earlier this month as the Chinese central bank lowered the one-year medium-term lending facility rate by 15 basis points (bps) to 2.5%, while the one-year loan prime rate (LPR) was lowered by 10 bps to 3.45%.

Unlike the United States, which has raised interest rates by as much as 525 bps since the tightening cycle commenced in March last year, China’s LPR has been lowered by 40 bps over the same period.

Naturally, with the widening interest rate differential, the US dollar has regained its momentum and continues to gain ground against major currencies, especially the Chinese yuan and the Japanese yen.

The onshore yuan rate has dropped approximately 5.2% against the greenback while the offshore rate is off by 5.4% this year alone. Both the yuan rates are hovering near record low levels or levels last seen in late 2007.

Due to the economic headwinds faced by China, the market estimates as to where the yuan is headed will have a significant impact on its traditional trade partners, including Malaysia.

The recent Market Live Pulse survey from 455 respondents estimated the yuan may weaken further towards the 7.6 mark against the US dollar and this may spell trouble for other Asian currencies.

Stressful for currencies

Assuming that the yuan does weaken to the 7.6 mark or more than 4% lower than its current spot rate, what does this mean for the rest of Asian currencies, in particular the ringgit?

Year-to-date, the ringgit has weakened against the greenback almost at the same quantum as the yuan’s offshore rate.

A further weakness of the ringgit towards the 4.80 to 4.85 mark is foreseen should the yuan fall towards the consensus estimates by the year’s end.

On the same note, the regional currencies too are expected to take a hit as most Asean economies are trade-dependent on China and a weaker yuan can only mean one thing – weaker regional economic growth and weaker currencies.

One does hope that the consensus is wrong in its yuan estimated forecast for this year.

Otherwise, central banks around the region will likely be under further pressure to contain domestic currency weakness, which could lead to persistently high inflation prints and even slower economic growth.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.