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Chinese Yuan

Posted on 09-Aug-2019 Comments  0

Chinese Yuan

The Chinese Yuan could be the currency to watch out for

During the week, the People’s Bank of China (PBOC) did something that global markets were apprehending for a long time. It let the Yuan slip below the CNY7/$ mark and that led to a near panic situation among most emerging markets, including India. For China, it was a logical response to the US move to raise tariffs by 10% on goods worth $300 billion. First, what exactly is this trade war implication?

Trade war triggers Yuan fall

The PBOC, which is the Chinese central bank, normally keeps the Yuan in a range. The sharp correction in the Yuan was last seen in 2015, when it had impacted all the EM currencies. The fall in the Yuan was much sharper this time around, going beyond the CNY7/$ for the first time in the last 10 years. The surprising part was that the Yuan did not stop and inched closer to the 7.1 mark. However, better trade surplus data from China and US threats of classifying China as a Currency Manipulator led to the Yuan gaining some strengthening towards the latter half of the weak. Trump tariffs would clearly mean that Chinese products get more expensive in the US. This makes Chinese products less competitive. The only way to arrest the slowdown that it was causing in China was to let the Chinese Yuan weaken. This would compensate for the higher costs and ensure that the Chinese exports engine did not suffer in a really big way.

Why Yuan is the worry

A weak Yuan is a worry for two reasons. Firstly, if China gets declared as a currency manipulator, then it could really roil the global currency market because the Yuan is now part of the IMF basket too. That is a situation which most countries would want to avoid. China also has a trump card in hand in the form of its $1.3 trillion in US dollar treasury holdings, which it could use as a bargaining chip to create chaos in the global currency markets. Secondly, for countries like India, the immediate problem is a weakness in the INR. Since the CNY problem began, we have seen the INR fall from 69/$ to nearly 71/$. That has serious repercussions for FPI flows, which has anyways been on a downswing since the Budget. The CNY devaluation could only make it worse.

Currency war concerns

The real worry for the world economy is that it could trigger a vicious currency war. The world has not seen a currency war in the last 100 years and such Chinese action could just about trigger a major currency war. In a currency war, each nation tries to boost exports by lowering the value of its currency. The only big risk in any currency war is that there are no winners. Currency wars typically lead to a weaker currency, lower output and major contraction in the economy. That is something that is best avoided at this point in time! 

Article 370

Article 370 is gone but the real Kashmir challenge may be ahead

On 05th July, the government passed a presidential ordinance scrapping Article 370 altogether. This was the document that had assured a special status for the state of Kashmir. Under Article 370, the Kashmir state government had total powers in all areas except in defence, foreign affairs and communication. So, what exactly does the abrogation of Article 370 really mean?

What after Article 370?

That appears to be the million dollar question in the minds of the people. What happens to Kashmir after the Article 370 has been scrapped. From the point of view of the people of Kashmir, it may not really make a big difference. The day the Article 370 was abrogated, the government also simultaneously promulgated a bill absorbing the state of Jammu & Kashmir into the Union of India and under the full aegis of the Constitution of India. Post this new Bill being promulgated, the erstwhile state of Jammu & Kashmir will stand split into two union territories. Jammu & Kashmir will be a UT with a legislature of its own while Ladakh will be a UT without a legislature. Since they are UTs, they will be under the direct control of Delhi. Once it becomes a part of the Union of India without the special status, the free movement of people would be possible both ways and that should ideally bring peace and prosperity to India’s own Switzerland. But the real challenges may be a lot bigger as we go ahead.

International reaction

Surprisingly, most of the economically powerful nations like the US, China, Japan and the rich nations of Europe have been surprisingly silent. That is perhaps because the media blackout has ensured that little news comes out. But the backlash could start soon. A world that has strongly condemned the Israeli occupation of Gaza and West Bank will not be able to remain neutral for too long considering that Kashmir has been an internationally disputed territory. There are 3 major reactions to be watched. Firstly, the US is yet to fully articulate its reaction but they do need Pakistan’s support at this point of time. China has been a long time ally of Pakistan and they have staked claim to Aksai Chin, which is part of Ladakh. Lastly, the OIC stand is not yet clear but that may hold the key for Pakistan.

After the curfew is lifted?

That is the real X-factor at this point of time. Kashmir has been quiet due to a curfew clampdown but that obviously cannot go on forever. Due to the media clampdown, there is not even the slightest evidence of how the people of Kashmir would react once the curfew is lifted. Also, Pakistan has made its displeasure clear and they would just get another opportunity to persist with their ambush strategies. The calm right now may be uneasy. The real challenge will be once the curfew is lifted! 

Mutual Fund Norms

SEBI once again tightens MF norms and rightly so

In the midst of a tumultuous week when most of the action was focused on Kashmir, the monetary policy and the global macro risks; SEBI tightened the screws on mutual funds a little further. In its last board meeting, SEBI had come out with a series of norms for MFs to become more transparent in their practices. This week, SEBI has gone a step further and rightly so.

Only listed securities please

In a clear moved aimed at discouraging mutual funds from investing in opaque companies, the regulator has now insisted that mutual funds can only invest in listed equity and debt. So, any investment in unlisted company equity or in debt that is in the form of private debt is not permitted any longer. The reasons for this move are not far to seek. In the last 6 months, a few large mutual funds had to freeze redemptions on their fixed maturity plans (FMPs) due to investments in illiquid paper where the issuer was on the verge of default. The advantage of focusing on listed paper is that all such listed debt paper has to be automatically rated by a rating agency. Also, the listing agreement compels these companies to adhere to more stringent standards of disclosure and transparency. Deals like Zee, where promoters struck private deals with fund managers, will not be permitted any longer. This will be a great move to protect the interests of the investors. After all that is the focus of SEBI!

Reduce unrated debt

The listed securities announcement will be applicable only to prospective assets acquired. But what about assets that is already in the portfolios of mutual funds. Here the regulator has offered an option for phased reduction. All debt funds holding such unrated paper in their portfolios will have to reduce their exposure to unrated paper from the current 25% to 5% in a phased manner. That means a lot of such privately agreed debt will have to be wound up and we may see more such redemption problems come to light. While that could create short term pain in the market, SEBI is of the view that it would clean up the system once and for all.

SEBI is bang on target

The reason SEBI is moving on such a war footing is that if the debt fund problem was allowed to fester, it could again lead to loss of investor confidence. Fund managers comparing of some FMPs talking like high-handed village chieftains has hardly helped build investors confidence. In most cases, SEBI has realized that the trustees to the fund were not in a position to enforce such discipline on the fund managers. While such regulation may appear to be tough on the funds, it is the right step from the perspective of investors. At Rs.25 trillion, Indian MFs are too big to be left to their own whims and fancies to manage money! 




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