Cai Jin

Why the yuan's fall matters to us

China's currency move caused commodities-dependent currencies to wobble and regional stock markets to fall.
China's currency move caused commodities-dependent currencies to wobble and regional stock markets to fall.PHOTO: AGENCE FRANCE-PRESSE

Homeowners must keep an eye on rising interest rates, as Sibor will face more upward pressure if regional currencies keep plunging

With the media fixated on the upcoming general election, few people outside the financial markets have paid much heed to China's recent move to ditch its "soft" peg to the US dollar.

But the bloodletting in the Straits Times Index (STI) and other widely watched regional barometers such as Hong Kong's Hang Seng Index suggests that this development deserves closer attention from all.

Since January, the STI has fallen by 11.7 per cent in Singapore dollar terms and 16.8 per cent in US dollar terms.

Half of the losses occurred in the past fortnight.

China's currency has tracked the US dollar for as long as anyone can remember, so its decision to end the dollar peg at a time when the region is faced with growing economic uncertainties and plunging commodities prices is viewed with anxiety by investors.

Trying to work out the implications of China's move is complicated by the fact that observers are not exactly sure what prompted it, or what is likely to happen next.

True, China had been keen to sell the idea that this step was taken to enable it to present the yuan as a market-driven currency worthy of a place alongside the US dollar, yen, euro and sterling, and to be named as a reserve currency by the International Monetary Fund.

Then there is the argument that if China is really serious about devaluing its currency to help the nation's exporters, it would have gone for a much bigger drop, rather than the 2.8 per cent fall which the yuan has so far registered against the greenback.

But the move took place against the backdrop of an eye-popping 8 per cent drop in China's exports last month from the same period last year.

This seems to confirm the bearish view that the Chinese economy may be in a worse shape than previously thought.

After all, Beijing has tried a host of measures in recent months to spur the economy, from cutting interest rates to lowering reserve requirements - the sum which Chinese banks must set aside for a rainy day - and talking up its stock market before it suffered an ignominious collapse last month.

So while changing the yuan's daily reference price from an official fixed level to the ending price of the previous trading session may seem innocuous, some market pundits view it as a natural progression of the measures that China is taking to revive its slowing economy.

Still, one question is why should investors even care about a slide in the yuan against the US dollar.

After all, one can argue that the yuan is only playing catch-up with other major regional currencies, such as the Japanese yen and the Australian dollar, which have plummeted by a much bigger margin. Even the Singapore dollar has lost 6.5 per cent against the greenback since January.

But China is not just any other country. It is a US$10 trillion (S$14.08 trillion) economy and any action it takes on its monetary policy affects the world.

During the Asian financial crisis 17 years ago, as one desperate Asian country after another devalued their currencies, China won widespread kudos for halting the malaise by keeping the yuan firmly pegged to the US dollar.

Seven years ago, when the world was engulfed in another huge financial firestorm, China again fixed the yuan to the dollar and launched a 4 trillion yuan stimulus package that whetted demand for everything from Australian coal to US cars.

Sitting on top of a huge US$3.7 trillion of foreign reserves, it should have been in a position to enforce any given foreign exchange rate that it wants to have.

So abandoning the peg can only mean that even China is finding it too costly to keep the yuan shadowing the resurgent greenback, which has been bolstered by falling energy prices, a reviving United States economy and the prospect of a hike in interest rates.

The fallout has been immediate.

Merrill Lynch's latest fund manager survey shows institutional investors have turned cagey about emerging markets, naming "China recession" risk as the biggest problem on the horizon.

They are also worried about commodities-rich countries which are closely linked to China's business cycle, as well as markets such as South Korea and Taiwan which have exposure to China through their non-commodity exports.

The result is a rout in regional stock markets and a wobble in commodities-dependent currencies such as the Malaysian ringgit and the Indonesian rupiah, both of which have fallen to their lowest levels against the US dollar since the depths of the Asian financial crisis in 1998.

For us, however, it is the potential fallout on the interest rates front that we have to be wary of, since many of us are saddled with huge mortgages on our homes.

During the Asian financial crisis, banks here jacked mortgage rates to as high as 7 per cent, even though Singapore was a relative oasis of stability amid the financial turmoil in the region, as the Thai baht and the rupiah plummeted.

No doubt, investors have responded to China's currency intervention by marking down their expectations of a rise in US interest rates next month.

This should offer relief to homeowners fearful of an interest rate hike here, since Singapore interest rates track the US market closely. But as regional currencies weaken in the wake of Beijing's so-called devaluation move, this is also causing the Singdollar to wobble and investors may demand a higher interest rate as compensation for holding a weaker currency.

Since January, the three-month Singapore interbank offered rate (Sibor), which is used to set interest rates for mortgages, has more than doubled to 0.93825 per cent.

Chances are that even without a US interest rate hike, Sibor will face further upward pressure if regional currencies continue to plummet.

Of course, this may just be a case of seasonal volatility.

But it looks like we are in for a bumpy journey with Sibor as regional currencies go on a roller-coaster ride.

Homeowners with big mortgages should pay attention to what the financial markets are telling them.

A version of this article appeared in the print edition of The Straits Times on August 24, 2015, with the headline 'Why the yuan's fall matters to us'. Print Edition | Subscribe