Asian Financial Crisis Redux

Moves in the global Forex markets are signaling that problems are brewing in the East.

The Yuan and Yen are weakening again. Is the Asian Financial Crisis about to hit again?

The Chinese yuan is currently trading at its lowest level against the dollar since November of last year. The pair traded at 7.2, which before last November had been only seen briefly in 2022 and in December 2007. This week, in a key move, China reduced the five-year loan prime rate (LPR), which serves as the benchmark reference rate for mortgages, by 25 basis points to 3.95% during a monthly fixing. This comes just as authorities intensify efforts to stimulate credit demand and revitalize the dying property market.

The drop was much bigger than anticipated by economists who had expected a decrease of only five to 15 basis points. It marked the most significant cut since the introduction of the reference rate in 2019.

China's economy is grappling with challenges stemming from a property crisis, falling consumer confidence, and ratcheting deflationary pressures. The central bank's cautious approach to easing is a far cry from investors' expectations of strong stimulus measures, which has caused a rapid collapse in the nation's stock market, as covered the other week. The real estate issue is also worsening, as homebuilder Evergrande has gone into bankruptcy and another developer Country Garden has defaulted on dollar bonds. I’ve written about the Chinese property crisis extensively, (here and here), but needless to say the situation is far worse than the authorities want to admit. 

Although the central bank has not lowered policy rates for several months, authorities have implemented a couple measures to reaffirm confidence. Recently, the PBOC injected long-term liquidity into the banking system by reducing the reserve-requirement ratio for lenders. Additionally, officials have tightened regulations on share lending for short selling and bolstered support for the yuan through adjustments to the central bank's daily reference rate.

The PBOC has also been injecting liquidity into the financial system through its primary lending facility for 15 straight months. Last Sunday's net injection of 1 billion yuan ($139 million) via the MLF was intended to maintain balanced liquidity following the week-long Lunar New Year holiday that began on February 10.