Five Key Risks for Corporate Cash Investors in China
by Aidan Shevlin, Managing Director, Head of Asia Pacific Liquidity Fund Management, J.P. Morgan Asset Management
Corporate investors in China have experienced enormous changes over the past twelve months. The combination of slower economic growth, rapid regulatory changes and unpredictable investment markets has created an environment of uncertainty and volatility making it difficult to determine which of the myriad perceived risks are genuine and in turn, how these can best be managed. To help, this article outlines the five key risks that corporate treasurers should consider when operating and investing cash in China.
While China’s economic growth rate remains strong and continues to outpace most other economies, the recent slowdown from the rapid pace of growth seen in the last three decades has inevitably caused concern for investors – especially given China’s economic importance. The size and magnitude of the slowdown and potential impact on domestic demand and corporate investment plans remain key questions. However, a slowdown was inevitable and is consistent with China’s increasing economic maturity. Furthermore, slower, more sustainable economic growth should lead to greater resilience and transparency and as such, economic risks should not be overstated.
The government and People’s Bank of China (PBoC) are actively focused on achieving a ‘soft landing’, using a combination of fiscal policy and easier monetary policy to stabilise the slowdown in growth. The government is also continuing its programme of regulatory reform at a rapid rate in order to create a more stable foundation for future economic growth and development.
There are other positive factors too. For example, China’s services sector continues to grow strongly, representing approximately 55% of China’s GDP and recently replacing the manufacturing and export sectors as the largest driver of economic growth. Both Chinese corporations and foreign multinationals operating in the services sector are experiencing strong growth opportunities.
The recent decline in the value of the Chinese renminbi (CNY), most notably against the USD has been a definite cause for concern amongst foreign corporates operating in China. After China ended the renminbi’s strict peg to the USD in 2005, the currency appreciated steadily for almost a decade, offering foreign corporate investors positive returns with limited downside risks. However, since early 2014, the value of renminbi holdings has declined and currency volatility has increased, most notably in the off-shore renminbi (CNH) market and in the difference between the PBoC FX spot and fixing rates.
The increasingly rapid pace of currency depreciation in recent months has fuelled speculation of further declines. However, the depreciation of the renminbi also needs to be seen in a wider context. No currency can appreciate indefinitely and increased volatility is the inevitable consequence of currency liberalisation.
As the USD continues to appreciate, driven by stronger US growth and expectations of higher Federal Reserve interest rates, the renminbi, along with many other global currencies will depreciate against it; however, it should be worth noting that the renminbi’s depreciation against the dollar over the past two years has been less than other major currencies.
Furthermore, renminbi is maturing as a currency: its inclusion in the International Monetary Fund (IMF)’s special drawing rights (SDR) basket, alongside USD, EUR, JPY and GBP is prestigious and an international vote of confidence in the reminbi. Currently the renminbi only represents 1% of global reserves while the on-shore Chinese bond market has grown into the third largest in the world. Both should benefit as international central banks and investors reallocate their investments to these new asset classes.
The change in the renminbi’s value and prospects creates very different conditions for corporate treasurers compared with just two years ago. Previously, China’s closed capital account was not a significant concern for foreign corporations, who were willing to let cash balances build up in China for extended periods to enjoy higher interest rates and currency appreciation. Today, with the value of the renminbi declining, corporate treasurers in China should optimise their cash balances to fulfil their entity’s investment and working capital requirements. Fortunately, this task should be easier to achieve now that China has committed to opening up its capital account, resulting in cash being less ‘trapped’ in China. That said, corporate investors in China should be mindful that challenges relating to free flow of capital will still remain in the short term.
Treasurers are becoming increasingly adept at assessing and managing regulatory risk; however, China offers particular complexities. Firstly, there are a number of different regulators that often have conflicting and/or overlapping objectives, so it is important to understand the role and objectives of each agency. Secondly, the pace of regulatory change has accelerated over the past two years, with substantial reforms, including the introduction of a deposit guarantee scheme, freeing up the interest rate mechanism, and opening up the intra-bank bond market to foreign investors. Both individually and collectively, these reforms have had, and will continue to have, a profound effect on the investment environment in China.