On January 19, 2017, four economists from BSI Economics (three banks, one rating agency) met to discuss the risks associated with the devaluation of the yuan and the impact of rising US sovereign bond yields on emerging markets.
The yuan appreciated by 1% in early 2017 after losing 4% in the fourth quarter of 2016
The revision of the currency basket used by the People’s Bank of China (PBoC) led to a reduction in the weighting of the US currency by around 4% (to which we can add the weighting of the HKD (indexed to the USD), which fell by 2.3%). However, indirect weightings must be added to this via newly integrated currencies indexed to the USD, such as the SAR (Saudi riyal) and the AED (United Arab Emirates dirham). As a result, the weighting of the USD has only fallen by 2.4%.
The effects of this new currency basket are mixed. On the other hand, the elasticity of the yuan’s daily fixing to a depreciation of the dollar has doubled since November 8, 2016, while the elasticity to an appreciation of the dollar has been reduced by 30%. The Chinese authorities seem to want to reduce capital outflows, with an estimated floor of 7 yuan to 1 US dollar.
More broadly, while strict capital controls despite a floating exchange rate regime may call into question the process of liberalizing the Chinese currency, pressure from parallel markets, such as Bitcoin, supports an acceleration of this opening up to foreign investors following the inclusion of the renminbi in the IMF’s Special Drawing Rights in 2016.
Fundamentals in emerging countries remain positive and resilient in the event of a further rise in the US dollar
At least two Fed Fund rate hikes are expected in 2017. This rise in US key rates is likely to increase upward pressure on the US dollar and increase the debt burden of emerging countries with a large share of external debt denominated in US dollars. Nevertheless, a stronger appreciation of the US dollar remains unlikely given the acceleration observed over the last three months in response to the rise in sovereign bond yields since the election of the new US president.
Economists use several criteria to select emerging countries and assess their sensitivity to a rise in US interest rates: (1) the level of external debt denominated in US dollars and maturing over the next 12 months, (2) macroeconomic fundamentals, and (3) the country’s credibility with its creditors.
Based on the first criterion, some analysts have been pessimistic about Southeast Asia, which has significant dollar-denominated debt and is also targeted by possible US protectionist measures. This would be the case for Malaysia, the Philippines, and Indonesia, countries that are particularly vulnerable to fluctuations/reversals in capital flows, or sudden stops.
However, credibility with creditors (third criterion) – i.e., repayment history, level of financialization, and political stability indicators – tempers this negative view, particularly for countries such as Thailand. Furthermore, fundamentals point to an increase in the volume of intra-regional Asian exports – particularly in Taiwan – and positive figures for Chinese growth in recent weeks. The consensus view was positive but cautious on the outlook for Asia.
Positive views were shared on Russia, Saudi Arabia—where new bond issues would be very welcome by the market—and certain South American countries. Higher commodity prices would benefit these countries, while the appreciation of the dollar would have a more limited effect on their debt due to the recent appreciation of their currencies.
