Three of the world’s largest banks have warned that the flood of “hot money” into China is at risk of sudden reversal as the yuan weakens and the US Federal Reserve brings forward plans to raise interest rates, with major implications for global finance.
A new report by Citigroup told clients to brace for a second phase of the “taper tantrum” that rocked emerging markets last year, but this time with China at the eye of the storm.
“There’s a dangerous scenario in which the combination of rising US short-term rates and a more volatile RMB (yuan) could lead to a rather large capital outflow from China,” said the report, by Guillermo Mondino and David Lubin.
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Speculators have been borrowing dollars to buy Chinese assets, a flow known as the “carry trade”. They often do so with leverage and through convoluted means, some involving use of copper or iron ore as collateral. The bet is that the yuan will strengthen, generating a near certain profit on the exchange rate. This has gone badly wrong as the central bank intervenes to force down the exchange rate, causing the yuan to fall 2.5pc against the dollar since January.
Nomura issued a client note on Friday warning that the carry trade is “reversing gear”, describing a break-down of discipline in which almost everybody in China from investors, to manufacturers, exporters, and commercial banks have been playing the game. Most of the borrowing has been in dollars and yen on the Hong Kong market.
Wendy Liu, Nomura’s China strategist, said investors are putting too much hope in the promise of fresh stimulus and infrastructure spending, ignoring the risks of a weak yuan.
She said devaluation is a double-edged sword. It helps cushion the shock of China’s economic slowdown, boosting “the razor-thin margins” on exporters along the Eastern seaboard. It may also mitigate the “coming wave of credit defaults”. But is also exposes the fragility of the system. A view is gaining credence that the weak yuan is an early warning sign that “China’s credit bubble may implode imminently”, she said.
The Bank for International Settlements caught the attention of central banks across the world — especially the Bank of England — with a report last October warning that foreign loans to China are now large enough to risk a repeat of the 1998 financial crisis in Asia.
“They have more than tripled in four years, rising from $270bn to a conservatively estimated $880bn in March 2013. Foreign currency credit may give rise to substantial financial stability risks associated with dollar funding,” it said. Analysts say dollar loans — to firms, not the Chinese state — have since risen to $1.2 trillion. Almost a quarter come from British-based banks.
Full article: Global banks issue alerts on China carry trade as Fed tightens and yuan falls (The Telegraph)
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