TOKYO -- The yuan's downturn has stopped after China narrowly avoided defaulting on a high-yield financial product, averting a potential crisis, but some fear that the resulting inflow of capital may fuel a bubble.
Investors breathed a sigh of relief when default was averted on a 3 billion yuan ($495 million) wealth management product issued by China Credit Trust. In Hong Kong markets, where regulations are less stringent than on the mainland, the yuan reached 6.03 to the dollar, ending a slide that brought it to the mid-6.04 range last week.
Although China's economy is slowing from its previous clip, it is still showing relatively brisk growth in the 7% range. The country has recently moved to loosen regulations on yuan-denominated investments, which is expected to bolster demand for the currency.
But the yuan's rise against the dollar will be slow in 2014, says Carmen Ling at Standard Chartered Bank. She expects the U.S. Federal Reserve Board's scaling back of quantitative easing to strengthen the dollar more in other emerging markets facing steep current-account deficits.
"China Credit Trust is overseen by the China Banking Regulatory Commission, so they likely wouldn't have allowed a default," says Chiyuki Shiraiwa at SMBC Nikko Securities. "But expectations of future bailouts may lead to reckless investment."
Many believe this incident may be just the tip of the iceberg. The balance of wealth management products sold at banks was 9 trillion yuan as of last June. With the People's Bank of China prioritizing a return to normal for the finance sector, the wealth management product problem will come into the open, Ling says.
To proceed with reform, the Chinese government will have to allow defaults on wealth management products and corporate debt this year, says Wei Yao at Societe Generale.