Charlie Awdry, Chinese Equities Portfolio Manager, provides his views on the central bank’s symbolic move to allow the yuan to weaken below 7.0 against the US dollar and its significance for investors.
Chinese equities generally earn CNY profits and have balance sheets dominated by CNY assets so a weaker CNY is clearly a headwind to returns for overseas investors who think in terms of USD, euro or GBP. Emerging market/ Asia Pacific investors can choose between many countries to invest in and hence often look to the USD as a base for earnings across countries. A lower CNY will generally lead to lower earnings forecasts for Chinese corporates, a feature that investors tend not to like and that can keep equity markets cheap.
We are extremely cautious on the equity of any company with offshore debt financing in USD and HK dollars. A particular concern to us is property equities because the sector is a very large issuer in the high yield offshore bond market. Funding CNY is cash consuming and generating businesses with USD debt is a problem if the CNY falls, as the effective debt load increases, and can cause solvency issues. Indeed, over the years, this has traditionally been the Archilles’ heel of corporate emerging markets.
As we have held a very cautious view on Chinese bank shares for over a year now, this CNY move reinforces our positioning with the potential for more credit quality issues. Credit quality issues originating from the property sector would not be a surprise but what is harder to determine are the unintended consequences of this move.
We will be monitoring the situation but it is probably fair to say that, if corporate China has seen the People’s Bank of China (PBOC) defend 7.0 to the USD for almost three years, those same corporates will have implemented a view that the CNY will not fall below 7.0 in financial decision making. While offshore funding is one obvious exposure, we will be watching to see where else risks will emerge.