China's weakening economy is dragging down the yuan

For the last thirty years, China has been a global economic powerhouse. Its growth has vastly exceeded the gradual gains of developed economies. Over this period, China has delivered double-digit growth on a consistent basis, lifting millions of its citizens out of poverty and challenging the US for the world’s largest economy. Not unlike the rest of the world, China experienced a severe slowdown during the pandemic. When restrictions were finally lifted in December 2022, most analysts expected a sharp rebound in growth. So far, the recovery has been tepid, and China is struggling to achieve even modest expansion.

Obstacles to Growth in China

• Real estate has been a linchpin in the Chinese growth story. The well-publicized problems with large developers have cast a pall over the domestic economy. Of the 50 largest real estate development firms, over two-thirds are currently in default, and more defaults are likely in the future. 
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• Consumers are increasingly wary of deteriorating conditions and have been pulling back on discretionary spending. Many have much of their net worth invested in real estate, so a shaky property market makes them reluctant to spend money. This lack of spending contributes to the current deflationary trend in Chinese prices.
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• Trade tensions between China and the US have caused many corporations to augment or replace their Chinese supply chains. “Friendshoring” and “nearshoring” have driven much investment to other countries, particularly those in Latin America. Deputy Treasury Secretary Wally Adeyemo told Bloomberg, “The Chinese are creating a less favorable environment for foreign direct investment and foreign companies."
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• China is seen as being hostile to domestic entrepreneurship and business development. Much of that is driven by Xi Jinping's authoritative rule and the perceived persecution of business leaders like Jack Ma of Alibaba. 
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• Government debt continues to rise, and the government debt-to-GDP ratio is expected to hit 84% in 2023 (It was 37% in 2013). Total (government and private) debt-to-GDP has climbed above 250%, meaning corporate and household debt has risen sharply.

Implications for Yuan

These obstacles to growth in China are not the only factors affecting the nation’s currency. China is among the few countries that have not raised interest rates during the last year, choosing instead to cut rates as other countries increase theirs. The ongoing downtrend in the yuan is being attributed to the People’s Bank of China (PBOC) recent lowering of the one-year prime loan rate to 3.45% from 3.55%. 

In other Chinese yuan news, the currency (USDCNH) has dropped by nearly 6% against the dollar in 2023 and is currently close to its weakest level of the year, with the PBOC warning that it does not want a disruptive move in the currency. However, its action has done little to curb the tide to lower prices.

Lastly, international investors are increasingly reluctant to buy Chinese corporate bonds due to a need for more transparency in data released by bond issuers. Diminished demand for yuan-denominated bonds will likely add to the pressure on the Chinese currency.

Long-term projections for Chinese economic growth have recently been revised downward. Some analysts even believe that China is no longer on track to overtake the US as the world's largest economy. 

‍Chinese Yuan News Takeaways:

The yuan appears poised for ongoing weakness against the dollar, with USDCNH recently moving above 7.25. Sustained trading above this level implies further depreciation, barring effective policy changes or intervention by the PBOC.

The slowing Chinese economy will likely have global implications, especially if China’s appetite for commodities continues to drop. This could hurt many emerging economies that rely upon revenue from exports of raw materials.

China's economic slowdown has multifaceted implications for the yuan, domestically and internationally. The yuan is influenced by China's economic health, trade dynamics, capital flows, and policy responses, the trends of which may not make for a strong currency. While a slowdown can potentially lead to a weaker yuan, history shows that Chinese monetary authorities have a strong track record of maintaining currency stability.

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