China's population lag, not a weaker yuan, set to be key as it battles younger Asian peers for investment

The volatility of the yuan may affect China's competitiveness with its Asian neighbours over the short term, but it is demographic factors that will be key in the long run as its younger regional peers have attracted more overseas merger and acquisition investment, economists said.

The onshore yuan closed at 6.8997 against the US dollar on Thursday, slightly weakening from the previous close of 6.8887, after the yuan hit a two-year low of 6.9 on Monday.

A hawkish address by US Federal Reserve chairman Jerome Powell last week on its aggressive plans to further raise interest rates to fight inflation has disturbed the global markets, leading to further weakening of the major currencies.

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The yuan's depreciation this year, though, is mild compared to other currencies in the Asia-Pacific, including the Japanese yen, South Korean won and the Thai baht.

As weaker currencies in Asia will improve export competitiveness, "an appropriate devaluation of the yuan within a controllable range is good for the overall exports", said Wang Tao, head of Asia economic research and the chief China economist at UBS, on Wednesday.

Mark Williams, chief Asia economist at Capital Economics, said a weaker yuan will help China's exporters as it is strong relative to other Asian currencies, but that there are costs associated with further declines.

"Policymakers worry that sustained depreciation against the dollar will trigger speculative pressure on the exchange rate as happened in 2015 and 2016," he said.

"And they worry that perceptions of yuan weakness might undermine their goal of establishing the yuan as a widely used global currency."

Pointing to the future, Natixis also confirmed that India and the Association of Southeast Asian Nations (Asean) bloc have surpassed China to become the top destination of overseas merger and acquisition investment.

"In the long term, demographic trends will be a key for Asian economies, in which China may lag behind its more youthful peers, such as India and Asean," said Alicia Garcia-Herrero, chief economist for Asia-Pacific at the French investment bank.

A youthful Asia, including India, Indonesia, Malaysia, the Philippines, Vietnam, Pakistan and Bangladesh, will see an increase of around 3 billion to their combined working age population, she added, which will create a huge need for jobs and infrastructures in the next two decades.

According to Natixis, foreign direct investment across Asia increased by 19 per cent in 2021 due to its "demographic endowment" and "infrastructure needs" that have attracted foreign capital.

Inflow into China increased by 20.2 per cent year on year to US$173.48 billion last year, figures from the Ministry of Commerce showed.

China's population grew by just 480,000 to 1.4126 billion last year, down from an increase of 2.04 million in 2020, while Chinese mothers gave birth to just 10.62 million babies in 2021, representing an 11.5 per cent fall from 2020.

Some demographers are convinced that China's population peaked last year, while the United Nations' "World Population Prospects 2022" report published in July said China is expected to see an absolute decline in its population as early as next year.

While China's Asian counterparts will see stronger economic growth, Katrina Ell, senior economist at Moody's Analytics, said that the bigger issue of an improved export competitiveness is "imported inflation", such as the current situation in both South Korea and India.

South Korea's inflation hit a near 24-year high of 6.3 per cent in July and India's headline retail inflation is expected to remain above 6 per cent until February, putting it above the central bank's upper tolerance range.

"Despite the hit from the US dollar, we expect Asian economies to remain resilient," added Garcia-Herrero. "The global supply bottleneck and commodity price surge have been a favour for some net-exporting Asian countries, such as Indonesia and Malaysia, and spurred their current account."

China still faces multiple headwinds, including its zero-Covid policy, a property sector slump and an adverse external environment, according to Yuting Shao, macro strategist at State Street Global Markets.

"Unless the real estate [market] can stabilise and rebound before the 'golden September and silver October', the yuan's exchange rate could breach 7 per dollar as early as September," warned Tao Chuan, chief macro analyst at Soochow Securities.

The yuan had emerged as more of a so-called safe haven currency after the pandemic erupted due to the low correlation between Chinese assets and other economies, Tao argued, but now the domestic Omicron outbreak and property risks have limited the currency's advantage.

Capital Economics' Williams, though, holds a different view about the yuan reaching the key psychological threshold of 7 per US dollar.

"The yuan is likely to remain under pressure for a while, but the [People's Bank of China] is likely to start pushing back more forcefully," he said.

"In past bouts of weakness, 7 against the dollar is a line that policymakers have tried to defend."

This article originally appeared on the South China Morning Post (SCMP).

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