Is China suffering from currency crisis?

11 March, AtoZForex, London – Since China has started the currency wars, massively devaluing its currency RMB multiple times, analysts are questioning the market could China be suffering a currency crisis? To with Bank of America Merrill Lynch (BoAML) provided its reasoning and further CNY outlook.

Could China suffer a currency crisis?

“Yes, but we see the risks currently as relatively low,” Bank of America answered, adding “our base case remains a gradual devaluation to 6.90 against the USD at year-end.”

A possible trigger for China currency crisis could be the domestic debt crisis, although the Chinese government appears to have the fiscal space to recapitalize the banks. Meanwhile, a self-fulfilling panic by retail investors is yet another risk. In this case, “tighter capital controls are more likely than a large devaluation in our view,” BoAML added.

The key point would be to watch fewer large global investors and more the mass of Chinese retail investors. If they panic and flee away from CNY, PBoC would simply not have enough reserves to satisfy demand for the USD.

“This could well become a second-generation crisis: if enough retail investors fear a crisis, it will be self-fulfilling,” Bank of America noted.

Of course, timing such an outcome is relatively difficult. Late heavy capital outflows from Chinese financial market have been mainly due to the unwinding of China carry trades. Analysts have been forecasting a double-digit devaluation in the CNY since the second half of 2015, with Goldman Sachs seeing 20% USD appreciation against the local currency. However, in the case of all second-generation model dynamics, the currency crisis is not inevitable.

How Chinese authorities react?

In the face of currency crisis risk, Bank of America base case is that “China has both the ability and the determination to avoid a crisis, and likely will devalue gradually and modestly over the rest of this year.”

Nonetheless, it would be prudent to keep close watch on these Chinese currency crisis risk scenarios, as above anything else, a global recession amid decreasing monetary efficiency could easily spur chaos.

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