China Black Swans Not So Rare Anymore as PBOC Shocks Markets

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What's the End Game for China?

Investors should prepare for more surprises out of China after the yuan’s devaluation became the country’s latest unexpected policy move to roil global markets.

That’s the advice from Fraser Howie, co-author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.” He says Chinese policy decisions are becoming “erratic” as authorities struggle to combat the nation’s deepest economic slowdown in more than two decades.

This week’s tumble in the yuan -- the biggest devaluation since 1994 -- comes just a month after unprecedented state intervention in the stock market deepened a $4 trillion sell-off. Two years ago, authorities triggered the country’s worst modern-day cash squeeze by restricting the supply of funds to the banking system. The failure of China’s decision makers to telegraph and explain those policy changes has increased volatility worldwide as traders struggle to forecast what happens next in Asia’s biggest economy, Howie said.

“This complete lack of signaling has investors, both foreign and domestic, completely spooked about what’s going on,” Howie, a former managing director at CLSA Asia-Pacific Markets, said in a phone interview from Singapore. “China has a huge influence globally and markets don’t like shocks.”

While investors parse every word in Federal Reserve statements for clues on future U.S. monetary policy, the People’s Bank of China provides few such details, while decisions are often the result of political wrangling, according to Howie.

“We don’t know what their policy is,” he said. “We don’t see minutes of meetings. We don’t get regular announcements, so we get a tremendous lack of transparency.”

Yuan Plunge

The PBOC took markets by surprise when it cut the daily fixing for the yuan by 1.9 percent on Tuesday, ending a four-month peg against the dollar. The currency tumbled 2.9 percent in two days, the most since the country ended a dual-currency system in 1994, while it now trades at the biggest discount to the offshore yuan since 2010.

Late-night announcements of measures to shore up the $7 trillion stock market during a 32 percent rout helped send volatility on the Shanghai Composite Index to the highest in 18 years. Even after officials banned large shareholders from selling stakes and ordered state-run institutions to buy shares, the benchmark equity gauge plunged 8.5 percent on July 28, leaving traders to guess at whether the government had withdrawn support. It was the biggest tumble since 2007.

Black Swans

In 2013, the central bank engineered a cash crunch that sent the overnight interbank lending rate to a record 12.85 percent on June 20, almost six times the five-year average. It wasn’t until June 28 that PBOC Governor Zhou Xiaochuan made his first public comments on the credit squeeze.

“These types of market-disrupting events out of China have picked up frequency,” Tim Condon, head of Asian research at ING Groep NV in Singapore, said by phone. “The authorities need to signal what they are doing so that the markets are better prepared.”

The yuan fell 0.2 percent at the close, while the Shanghai Composite Index rose 1.8 percent.

For Gerry Alfonso, a sales trader at Shenwan Hongyuan Group Co., China is more exposed to such “black swan” events due to the relatively short history of its capital markets and an economic slowdown after years of fast growth.

“The positive thing is that these policy changes are intended to support the market, so even if they are impossible to forecast, they should give equities some type of floor,” Alfonso said.

Economic Impact

The term black swan was popularized by Nassim Nicholas Taleb’s 2007 book with the same title. It’s a metaphor for an unforeseen catastrophe and derives from the once widespread belief in the West that all swans were white, until European explorers discovered black swans in Australia.

Decisions by China’s policy makers are having a greater impact on the rest of the world as the importance of its economy and financial markets increases. The nation accounted for 38 percent of global growth last year, up from 23 percent in 2010, according to Morgan Stanley. Its stock market is the second-largest after the U.S., while the yuan ranks third behind the dollar and euro in terms of trade finance, according to the International Monetary Fund.

President Xi Jinping is seeking a greater role for China in overseas markets, with officials pushing for the yuan to attain reserve-currency status at the IMF and the inclusion of mainland equities in MSCI Inc.’s global benchmark indexes. Both the IMF and MSCI deferred decisions in the past two months on the issues, suggesting there is more work to be done by China’s authorities to open capital markets and reduce intervention.

“Surprising markets seldom elicits a good response.” Howie says.

— With assistance by Allen Wan, Shidong Zhang, and Kyoungwha Kim

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