What China’s crackdown means to US indices and other emerging markets?

Rather than listing on the US exchange and comply with their standard, Chinese authorities are tightening the scrutiny of overseas IPO-bound firms and ban those that collect vast amounts of user data. Further, all internet firms planning to go overseas would be asked to voluntarily apply for reviews with the powerful Cybersecurity Administration of China (CAC). From the US front, SEC has started to send detailed instructions about disclosure of their use of offshore vehicles known as Variable Interest Entities (VIEs) for IPOs. VIE in modern time have been misused as this structure allows to keep some assets out of the corporate balance sheet and without putting the whole enterprise at risk. Many Chinese VIEs are incorporated in tax havens such as the ‘Cayman Islands’.

During this crackdown, the sectors which remained under watchdog includes entertainment, gaming companies, sharing economy (ride-sharing, bike-sharing, home sharing), tech/algo based companies, cloud computing platforms, education, online finance, cryptocurrencies, property, etc. The most affected companies include Alibaba Group whose US-listed share prices have shed more than $400billion in value since late October, Tencent Holding who lost more than $347 billion in market value, DIDI Global also lost about $37 billion, or more than 40 percent of their value. There were few education-based online tutorial companies like Rise Education and New Oriental who lost more than 85 percent of their market value.

There are minimum 250 Chinese companies listed on the three major US bourses with a total market capitalization of $2.1 trillion and there are eight national-level Chinese state-owned enterprises listed in the U.S. The NASDAQ Golden Dragon China Index (HXC)- a gauge of Chinese companies listed on the US market and majority of whose business is conducted within the People's Republic of China, fell by more than 53 percent in just 6 months. The recent turmoil will not just threaten the IPOs in the pipeline but could also upend the popular Chinese ADR market. This suggests that ‘China’s technology bubble’ is bursting slow and steadily. This could unfold a new risk-off wave across globe and could lead to higher demand for the safe-haven currency-.dollar

The steady tightening of the regulation from Chinese authorities is pressurizing on the Chinese market and Hang Seng index. However, PBoC is closely watching its impact on the Yuan. Unlike other major currencies like USD or JPY, Yuan is not a free-float currency. The rate is maintained by China mainland and PBoC sets the so-called daily midpoint fix.

However, the bigger implications of the same could start impacting the offshore Yuan over the short to medium term, and hence onshore could track that too. Just like 2019, when Yuan was depreciated beyond 7 mark due to the ‘US-China trade war’. We are expecting that Yuan doesn’t have much room to appreciate beyond the 6.35-6.40 zone and could start depreciating towards 6.65-6.80 levels in upcoming time. The likely impact on EM FX will depend on the flows. If China’s FDI/FII flows are diverting to any other emerging market then that country’s currency will remain unaffected. However, this could question one country’s competitiveness vis-a-vis Yuan.

As China remains an immediate competitor of India having similar economic dynamics, although way behind in terms of many aspects, but would have a positive impact on the Indian market. Unless any major risk aversion happens due to the same, India will remain a favourite market for the FDIs. This doesn’t mean that Rupee will start appreciating, because RBI is closely tracking the flows, trade balance, and reserves. They are immediately intervening in the market and start rescue operations for the exporters whenever Rupee appreciates beyond certain level. Further, a higher Rupee versus Yuan will erode the competitiveness of India’s exports; especially, during a time when there are many hurdles on the shipping front. Hence, we could see a range-bound movement in Rupee, with some hiccups on any sudden news from Chinese authorities.

We need to understand this- Bigger the economic size, Bigger the Problem will be, and Bigger the impact on the global financial market. China’s crackdown is now new normal for the market, just like the Trade war. The implication of the same will remain unfavourable for China over the medium term. Hence, Yuan could come under pressure in the upcoming time. Even if PBoC tries to loosen its monetary policy and rescue the currency, it could depreciate towards 6.65 to 6.80 levels. The FDI flows could divert towards other opportunistic markets where the differential will give alpha return to the investors. But that country’s currency movement will purely depend on the central bank’s target level and their tolerance.