2015 ended with falling commodity prices, weakening EM growth momentum and increasing concerns about EM capital outflows. Deepening political crises in Brazil, South Africa and Turkey caused additional market nervousness in the last weeks of the year. The combination of expectations of tighter US monetary policy on the one hand and concerns about EM deleveraging, financial risks and deepening political crises in the problem countries should keep the pressure on the emerging world high in 2016 as well. The most important issue remains the Chinese situation of declining growth, increasing leverage growth, less effective economic policies and accelerating capital outflows.
The most recent source of EM risk aversion has been the depreciation of the Chinese renminbi. Since the mini-devaluation of last August, the authorities in Beijing have been managing the renminbi exchange rate relative to a basket of currencies of main trading partners. After the nominal effective exchange rate had appreciated by some 30% since 2011 (when most EM currencies started to depreciate), it stabilized in the second half of 2015. From the recent sharp daily moves relative to the US dollar – something which the Chinese had always avoided – we can now deduct that Beijing is strongly committed to avoid appreciation against the basket of main trading partners.
This decision makes a lot of sense given the weakness in the Chinese export sector and the importance of this sector for Chinese employment. Even more so because of the capital outflows that to a large extent are driven by the perception that the renminbi remains overvalued.
The problem for financial markets, however, is that a rapidly weakening renminbi means that an important anchor for EM currencies has disappeared. With the renminbi allowed to weaken relative to the US dollar, it is likely to keep pace with the other EM currencies and the euro. The latter is particularly relevant given the efforts by the ECB to push the euro weaker. Europe is China’s largest trading partner.
Another reason why the recent large CNY moves have created new unrest in financial markets is that they suggest that the economic problems in China might have become too big for the old gradual policy approach.
M.J. Bakkum is Senior Emerging Market Strategist at NN Investment Partners.