What do you do with a Renminbi bounty? How China has responded to volatility of the Yuan
A very detailed insight into the methods by which Chinese investors pay for services, invest in markets and the general dynamic of how the Yuan is an instrument which is traded via electronic means that are so advanced that an entire ecosystem exists around it that differs from every other currency and every other market
By Adinah Brown, Leverate
If the global financial markets was a school yard, then China is a giant that entered the playing field, not completely aware of how strong it actually is compared to all the other kids pining to score a goal.
As an emerging player in the international trading game, we take a look to see why the China-giant-kid is not only fully aware of its own financial strength, but how a brokerage trading service can help Chinese traders keep the value of the “strength” that they have.
The reason that China is not sure of its full financial “strength” is due to a number of factors. In some ways it can be likened to an adolescent, who is beginning to shed its domestic (childlike) activities that has been fostered by years of restrictive communist control of monetary policy to join the adult international market economy.
But this, like all transitions has its growing pains, as China seeks to streamline its existing structures to fully compete on the global scale.
One of the most significant difficulties it faces, is dealing with the long held shadow banking system. “Shadow banking” relates to all financial transactions that occurs outside of formalized and regulated banking institutions.
This makes it impossible to account for the total GDP, according to a report published by Moody Investor Services, and masks the true levels of debt in China.
Another factor muddying the waters is the recent exponential growth of the Chinese middle class with disposable income. Over the past few decades China’s emerging middle class has swelled to unprecedented levels, funded largely by high leverage provided by the shadow banking industry.
Their largesse was encouraged by strong consumer confidence and economic and industrial activities. The 2015 economic slow-down changed this, with a devaluating Yuan, lower Manufacturing Purchasing Managers Index (PMI) and plunging housing prices, causing many to transfer their Yuan into other currencies.
With the situation as volatile as it was, precedent has shown that when the Chinese get nervous, they tend to invest their money abroad.
Seeking developed economies with less volatile markets than their own. While China used to account for only a small percentage of total foreign direct investment, this trend underwent a steep upward transition, with the Yuan flooding cash flows into real estate markets across several countries.
Australia, China’s developed neighbor in the APAC region, has seen the value of its properties in cities along the east coast rise dramatically, which has been attributed to the purchase activities of Chinese sovereign wealth funds.
In London, Chinese investors have snatched up high end apartments and skyscrapers in the central business district. The U.S. is no different, with purchases of luxury condos and prime retail property being made on both sides of the coast and incrementally towards the country’s center.
What may be interesting is that these buyers are not only big investment groups, but often less wealthy individuals who are well informed and have a broad international perspective with the aim of protecting their hard earned, but unstable Yuan.
The Volatility of the Yuan
The Chinese Yuan may be falling, but all expectations show that it’s going to fall further still. Most analysts and investors are certain that the Yuan is going to fall further against the dollar, the only questions are by how far and how quickly.
This uncertainty reflects a new reality, the government which for a long time exerted significant control over the Yuan, predominantly by pegging it to the USD, started to relinquish its grip.
In 2015, the government incorporated a loosening of capital controls, with the purpose of making the Yuan more flexible and also more responsive to global market trends.
However, the dollar’s increasing strength over the last two months has caused the Yuan, like most other currencies, to steadily lose ground against the greenback.
More recently, the People’s Bank of China (PBOC) ratcheted up a series of controls that sought to cap investments in international financial markets.
Starting from 1st December 2016 new rules came into effect to prevent companies from acquiring foreign assets. The decision was prompted by the PBOC concluding that a sizeable number of foreign acquisitions were being used to mask capital outflows.
Yet even despite these measures, the central bank has continued to dip into its reserves of foreign exchange in order to prop up the Yuan.
Although, still possessing the world’s biggest reserve with more than $3 trillion, the bank has consumed on average $10 billion a month since January 2016.
These staggering figures aside, the advisory group Logan Wright of Rhodium believes the government’s intervention is even more aggressive than what these figures indicate, pointing to the spike in trading volumes that are occurring in the onshore market.
China is truly stuck between a rock and a hard place in terms of keeping its control over the Yuan. Depreciation would infuse further momentum into financial outflows.
A big one off devaluation is too risky and would certainly tarnish the sense of financial security for the already volatile currency.
On the other hand, more rigid capital control could have the effect of harming the economy, where being any more protectionist would effectively close China off from the rest of the world. The only possible saving grace would be a weaker dollar, and while this is something that Trump has voiced an aspiration for, it is certainly a factor beyond China’s ability to control.
The Impact for PSPs
The rules passed by the PBOC entail significant restrictions on China’s widespread use of online PSPs. The use of mobile payment processors, like Alipay, is so prolific that for many Chinese consumers, they have entirely replaced retail bank accounts.
Partially, it’s the app’s versatility that makes them so popular; payments can be made for utility bills, transportation costs, donations to charity or even to split a restaurant bill.
More than that, the apps offer savings accounts with high annual interest rates along with investment products and wealth management funds. The veracity of what these payment apps offer does not have its counterpart in the West, with the closest possible likeness being “PayPal on steroids”.
The person to person payment system that is facilitated in Alipay and WeChat’s payment solutions integrates exceptionally well into the Chinese culture of conducting business. This outlook is best explained by the Chinese aphorism “First we meet as strangers, then we meet as friends, and afterwards we only meet as family”.
The trust that comes with personal interaction is implicit
When you understand this, it’s not surprising to learn that these payment apps are integrated into people’s social networks and are free.
In China people don’t use cash, they don’t use check or do bank wires, rather more than half a billion people use their apps to pay for everything. Businesses of every size from corporate companies all the way through to the mama and papa stores, are making and receiving payments by scanning QR codes with their phones.
The hurdle to this digital age follows a unique progression that could not be replicated elsewhere. Unlike the West, there is no trusted legacy of the banking institution. The population has catapulted from poverty to middle class in just a matter of 15 or so years.
Which means there is no 100 year legacy of established retail bank brands that consumers trust to grow and invest their capital. At the same time, this is a huge chunk of the population that leapfrogged PC’s to arrive at mobile phones and all its related features.
When you consider that in the first half of 2016, 455 million users conducted 62,644 billion transactions online in China, you get a sense of the bearing of the PBOC’s new regulations. Alipay, a subsidiary of Alibaba Group Holdings and the biggest online payment processor, is expected to lose a huge proportion of its market due to these new restrictions.
The new PBOC regulations allows for three types of bank accounts. A Type I account has all the functions of a normal bank account and allows the holder to make payments, transfers and investments of any amount, but it can only be used via the traditional banking system, which doesn’t allow for foreign exchange.
A Type III account is restricted to a balance of less than 1,000 CNY, with a daily and annual transaction cap of 5,000 and 100,000 CNY respectively. The Type II accounts functions similarly to a Type III account, but for a higher balance. Both Type II and III accounts must be held at the same bank that already holds a person’s Type I account.
Under the new rules, any individual wishing to use a non-bank payment service provider such as Alipay must use a Type III account and has an annual limit of 100 transactions.
Previous account which were only registered with a mobile number will have to be updated with more details or removed from the system.
All accounts with PSPs need to be active; an account with no transaction in the past six months will be suspended and verification will be required for re-activation. These restrictions will not only limit the scope of Alipay’s activities within China, but it has achieved the PBOC’s objection of preventing wide scale, frequent, capital outflows.
While these changes hardly come as good news to Alipay and other mobile payment service apps, it has created a veritable gold rush for Bitcoin, in an elimination of alternatives. Long considered a competitor of Alipay, the cryptocurrency’s ability to fly under the radar of banking regulations, in this case, has worked in its favor.
Bitcoin blossoms, but not without its own concerns
In 2016, the Yuan dropped by more than 6.5 percent against the USD, a woeful performance that has not been seen since 1994. In contrast, Bitcoin experienced steady increases which in the first few days of 2017 saw its value tip over the $1000 mark, a near record high for the cryptocurrency.
The steadily increasing value of Bitcoin and the relative anonymity that it affords, has made it a highly attractive alternative funds transfer system for tech smart Chinese. Enabling them to not only hedge their money against the Yuan but also skirt around rules that would enforce limitations on the amount of foreign exchange that they could otherwise buy.
In those early and heady days of January, a number of Bitcoin exchanges came under the scrutiny of the PBOC, causing the price to slide downwards by more than 16 percent to 5,313 CNY (equivalent to around $766).
The PBOC alleged that there were irregularities in the operations of major exchanges, causing officials from PBOC to meet with key exchanges; BTCC, OKCoin and Huobi.
While PBOC claimed it was conducting spot-checks on leading bitcoin exchanges to assess for a range of possible rule violations, including market manipulation, money laundering and unauthorized financing, Bobby Lee CEO of BTCC claimed “it wasn’t so much of an investigation as much as an attempt to work closely with us to learn more about our business model”.
While certainly a-glass-half-full outlook, perhaps Lee has good reason to be optimistic, at least in relation to the value of Bitcoin. To say that Bitcoin’s value is strong is an understatement. Bitcoin which was valued in 2011 at less than $1 USD, reached a peak of over $1,000 USD by 2013 before a sudden drop, while in the last five years it has seen a continued growth of 4.475 percent.
However, it is not a currency that is free from its own volatility either, with concerns that China’s dominance of Bitcoin could make it easier for the PBOC to exert its control. Bitcoin is virtually a home grown product with an estimated 70% of all mining taking place in China.
It trades at a premium in China, as its absence of trading fees encourages high volumes and boosts demand. Furthermore, Charles Hayter, CEO of digital currency analytics firm Cryptocompare, found that “trading between the Yuan and Bitcoin accounted for around 98% of the total market in the last six months.”
Most analysts appear to be taking a wait-and-see approach. Hayter is of the opinion that this oversight of the currency is a good thing for the long term.
There is a fear that the PBOC’s investigation could lead, in the worst-case-scenario, to funds being withheld from Chinese investors or a finding that one of the exchanges has conducted itself improperly, which in the short term has already shown to affect volumes.
However, the long term implication could entail more rigor in the Chinese market, particularly as the PBOC has simultaneously been investigating the opportunity of establishing its own virtual currency. Bitcoin may be catapulted into maturity as a legitimate currency that will benefit from improved respectability.
As the Chinese currency continues to weaken, more Chinese will be looking to hedge their financial savings to ensure that it doesn’t lose its value.
This creates a fantastic opportunity for Forex and CFD brokers, especially if they play their cards right. Trading forex in China is clouded in a grey area, people who want to engage forex or CFD trading need to avoid legal hurdles by transferring their money to a broker’s bank account outside of China.
There is a 2% transaction fee that is imposed for every exchange and if that wasn’t enough, no leveraging is allowed at all.
While The PBOC has certainly created additional hurdles that you might not have to counter in other parts of the world, the demand for foreign exchange trading is relentless and Bitcoin might just be the answer.
Although, the future of Bitcoin is not clear, the entirely unique paradigm means that it can effectively circumnavigate these government restrictions.
Another added appeal of Bitcoin, is its heightened popularity and volatility, where brokers may want to consider providing this product in CFD.
After all is said and done, where there is a will to trade, Bitcoin appears to have provided the way.