Moderate depreciation of the yuan is to lift China's A-share market

As the U.S. Federal Reserve gradually withdraws its quantitative easing policy on the basis of economic recovery, the American dollar will enter a phase of continuous interest rate increases. Its appreciation will become an inevitable trend. Against this backdrop, the Chinese currency, the yuan, will face more depreciation pressure. As a matter of fact, the time for the yuan to moderately depreciate has come, judging from both external and internal factors. Moderate depreciation of the Chinese currency is not only beneficial for economic recovery, but will also lift China's A-share market.

External factors will inevitably weaken the yuan. Right now, the U.S. economy is taking the lead in the sluggish global economy. While the dollar is bound to appreciate after interest rate increases, the eurozone and Japan continue to implement their monetary easing policies, which will lead to a weaker euro and yen.

The International Monetary Fund (IMF) warned on July 23 that a further rise in the U.S. dollar as a result of the widening monetary policy gap between the United States and other major economies could have a significant negative impact on other countries. In its annual spillovers report, the IMF said lower oil prices, more monetary stimulus in the eurozone and Japan, and expectations of interest rate rises in the United States and the United Kingdom have created a "spillover-rich" environment. The depreciation of non-dollar currencies will cause global capital to flow out of emerging markets and into the U.S. market, leaving the yuan with depreciation pressure.

Domestic factors also stand in the way of a stronger yuan. An increase in productivity and a strong economic rebound is yet to happen in China. A country's exchange rate is ultimately determined by its productivity. With rising labor costs, salaries are growing faster than the GDP in China, leading to declining productivity. In theory, the government-backed entrepreneurship and innovation campaign will increase China's productivity but the campaign is yet to bear substantive fruit.

Although Chinese GDP grew 7 percent in the first half of the year, overcapacity hasn't been completely resolved. In that period, the total profit of industrial enterprises with principal business revenue of over 20 million yuan ($3.15 million) each amounted to 2.84 trillion yuan ($458 billion), down 0.7 percent year on year. Since the beginning of the year, the Chinese Government has put forward several development strategies - such as Internet Plus and Industry 4.0 - to boost economic growth.

[The Internet Plus concept, presented by Premier Li Keqiang in his government work report in March, seeks to integrate mobile Internet, cloud computing, big data and the Internet of Things with modern manufacturing to create a new engine for economic growth. Industry 4.0, which started as collaboration between the German Government, research institutions and businesses to develop fully automated "smart" factories, is also called the new Industrial Revolution.]

But these strategies are yet to become real growth drivers.

It takes time for the country to adjust its economic structure and cultivate new growth points. The pains of economic transformation are unavoidable. To maintain stable growth, China's central bank lowered its interest rates and reserve requirement ratios (RRR) several times since last year, which makes it unfeasible for the yuan to maintain its strength.

A moderate depreciation of the yuan is needed to boost China's foreign trade, which is mired in difficulties due to weak external and domestic demand. Trade growth failed to meet the target three years in a row from 2012 to 2014. In the first six months of 2015, China's foreign trade totaled 11.53 trillion yuan ($1.86 trillion), down 6.9 percent year on year, with exports increasing 0.9 percent and imports decreasing 15.5 percent. During the period, bilateral trade with the eurozone and Japan decreased 6.8 percent and 10.6 percent respectively, indicating substantive difficulties faced by exporters. The difficulties were caused by both weak external demand and sustained yuan appreciation, which caused Chinese exports to lose their low-price advantage.

Due to these factors, the yuan faces increasing depreciation pressure. Is it a good or a bad thing for the currency to depreciate? In my opinion, moderate depreciation of the yuan will help lift the domestic economy; therefore, the advantages outweigh the disadvantages.

Domestically, insufficient demand, shrinking new orders and rising labor costs have restricted economic rebound. A loose monetary policy is needed to spur growth. Interest rate cuts and RRR cuts by the central bank are targeted at injecting liquidity in the market and lowering financing costs for businesses amid economic slowdown. With sufficient liquidity in the domestic market, the yuan is unlikely to remain strong against other currencies. On the other hand, moderate depreciation of the yuan can help lower prices of Chinese exports. The yuan has appreciated 12 percent since July 2014, in conjunction with declining foreign trade in China.

In addition, a depreciating yuan and declining interest rates will make bank deposits less attractive and equities investment more attractive. A sharp housing price rebound is unlikely as the market is still destocking its large inventory. Therefore the housing market is not preferred by investors. The stock market will become a favorable investment object for many people. Although the stock price slump from mid-June to the beginning of July startled many investors, a recent market stabilization following government-backed intervention will attract more investors. Inflow of new capital will help invigorate the vulnerable stock market.

Having peaked after several years of bullish run, the U.S. stock market is likely to enter a stage of market adjustment, especially after the Fed tightens the monetary policy. With a sluggish global stock market, if China's A-share market can continue its bullish trend, global capital will flow into the market, which is good for the internationalization of the A-share market as well as the yuan.

Without any doubt, moderate depreciation of the yuan will inject vigor into the stock market and help sustain a bullish run.

The question is, how much depreciation is moderate? In my opinion, if the yuan depreciates against the U.S. dollar while remaining a stable exchange rate against major non-dollar currencies, such as the euro, the pound and the yen, the depreciation should be considered moderate.