Traditional theory says a cheaper currency should be good news for an export-dependent nation that's losing ground to lower-cost rivals. That doesn't apply in China's case, and its banks could be next to suffer the consequences.
Investors have good reason to worry as debt continues to explode and money keeps flowing out of the country. Goldman Sachs says a rising amount of capital is leaving China in yuan rather than dollars and the moves can't be explained by market-driven factors, Bloomberg News reported Tuesday. The same day, the People's Bank of China set the yuan fixing at the lowest since September 2010.
In other circumstances, depreciation might be expected to stimulate export manufacturing and attract overseas capital. That won't be the primary effect here. Instead, Chinese savers will get even more spooked that the value of their funds is dropping in dollars and will seek to move more money out of the country.
Outflows in turn will further weigh on the yuan in a vicious cycle that could have serious effects on China Inc., especially given that the country's corporations have taken on record amounts of foreign currency debt. This year alone, dollar- and euro-denominated loans taken out by Chinese companies have reached $195 billion, bringing the total outstanding to about $650 billion. That's equivalent to the total amount of subprime mortgage loans outstanding in the U.S. in 2008.
Foreign currency losses were already a major topic for publicly traded Chinese companies. The yuan has declined 3.3 percent against the dollar this year after dropping 4.4 percent in 2015. If the carnage continues in tandem with the rise in offshore debt, this will be an even more dominant theme in 2017. More losses could mean additional bankruptcies after what's already been a record year for corporate failures.
The bigger risk is that the banking sector will start feeling that pain. S&P Global Ratings said Tuesday that if China's corporate debt doesn't stop growing, it could cost banks $1.7 trillion (the amount of extra capital they would have to raise.) Some of the effect is already seeping through. The State Council, China’s cabinet, issued guidelines Tuesday for reducing corporate debt and for how banks may swap bad debt to equity. That means lenders could soon find themselves managing hundreds of ailing companies, most of them in sectors with little prospect of turnaround, such as steel or coal mining.
The sum of special mention and non-performing loans has already risen to 5.8 percent of the total in the second quarter from 3.6 percent two years ago, ANZ calculates. S&P predicts that problematic credit in bank balance sheets could triple to 17 percent of all loans by 2020.
If the yuan continues to depreciate at this pace, that number may arrive much earlier.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
((Adds Goldman's comments on capital leaving China in yuan rather than dollars in second paragraph.))
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