Chinese Market Update - August 2015

Chinese authorities face some difficult decisions balancing competing policy objectives around the Chinese currency. Supporting the strength of the Renminbi to prevent capital outflow may erode export competitiveness and interfere with monetary policy. But then, the China story has never been a straightforward one.

The China story has never been straightforward with bumps expected along the way.

The Chinese Renminbi (CNY) has been amongst the world’s strongest currencies.  Over the last five years (notwithstanding the recent 4% depreciation), the CNY appreciated 6.1% against the US dollar.  Over the same period, the likes of the Euro and the Japanese Yen lost ground against the US dollar to the tune of 27% and 37% respectively!  More importantly, the CNY has been a stronger currency than most of its export competitors.

Given the disparity, market pressure against the CNY strength has been considerable.  Instead of letting the CNY depreciate based on market forces, Chinese authorities have been supporting the currency, fearing a depreciation will trigger further capital outflow.  Apart from eroding its export competitiveness, artificially supporting the currency reduces the authorities’ flexibility to manage its monetary policies.  For instance, cutting interest rates will push down the CNY, which conflicts with the goal of CNY stability.  Given the slowing Chinese economy, policy relaxation is indeed much needed.

The 4% depreciation thus far is probably insufficient.  If depreciation pressure persists, how long the currency can stay expensive depends on the size of China’s foreign reserve war chest.  Foreign reserves stand at around US$3.6 trillion.  From 3Q 2014 onwards, it has been draining at a rate of around $25 billion a month, with some acceleration in July and August.  As the cost of holding the line becomes too high for the authorities, the CNY will most likely be allowed to depreciate based on market forces.

While further depreciation may come as a shock to market observers, we believe it is beneficial to China.  It offers China a greater ability to cut interest rates and improves its export competitiveness.  However, the impact on competing economies like Indonesia and Malaysia will be less favourable.

The Platinum Asia Fund has been reducing its invested position over recent weeks to around 78%.  This has softened the impact of market turbulence somewhat.  The Fund has also started hedging our CNY exposure, essentially positioning for a potential policy relaxation and currency weakening.  Stock exposure to Indonesia and Malaysia is kept to a minimum.

The China story has never been straightforward with bumps expected along the way.  In uncertain times, the opportunity-set opens up for a stock picker, as strong businesses with long-term growth trajectories in the region are starting to trade on very attractive valuations.  These companies will be bigger in 3-5 years’ time, even in a slower economic growth environment.  The challenge, in this volatile environment, lies in optimising the deployment of the Fund’s capital and to take advantage of irrational longer-term pricing.

DISCLAIMER: The above information is commentary only (i.e. our general thoughts). It is not intended to be, nor should it be construed as, investment advice. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances. The above material may not be reproduced, in whole or in part, without the prior written consent of Platinum Investment Management Limited.