Em fx weekly 13 aug

EM FX Weekly Change in China’s FX regime

Group Economics Macro & Financial Markets Research

Roy Teo +65 6597 8616Arjen van

Dijkhuizen, +31 20 628 8052

13 August 2015    

Change in China’s FX regime leading to a lower yuan… …to support the economy and to facilitate the take-up in the SDR basket …but the pace of depreciation will not be aggressive Our new year-end forecasts for USD/CNY: 6.55 (2015) and 6.75 (2016) respectively

Change in China’s FX regime…

…but pace of depreciation will not be aggressive

This week’s big move was the change in FX regime by the

Meanwhile, the PBoC also faces some constraints with regard

People’s Bank of China (PBoC). The USD/CNY fixing was

to a weakening of the currency. A sharp yuan depreciation in

adjusted by a cumulative 4.7% from 11-13 August. These

the yuan may spark currency wars and exacerbate capital

adjustments were in line with the Tuesday statement, indicating that the fixing of the reference rate would be based more on actual market movements. On Thursday, the PBoC calmed financial markets by signaling support for the yuan. So far this week the yuan has weakened by around 3%

outflows that China is seeking to contain. A much weaker yuan will also raise the debt repayment burden of entities with high US dollar –denominated debts. A sharp depreciation in the yuan may also result in less confidence for central banks to accumulate the yuan in their foreign currency reserves, which would run counter to China’s strategic goal to promote the global use of the currency.

…to support the economy…

We think that this is a logical step from a Chinese perspective,

In addition, businesses’ demand to use the yuan as a trade

as a weaker currency is needed to support the economy. A

settlement currency may also decline. This could have

weaker yuan will help China to restore export competiveness,

negative consequences on IMF’s assessment on how widely

given the lacklustre export performance and also result in

used and traded the yuan is ahead of SDR basket decision

some upward pressure in inflation. The strong yuan has

later this year. Furthermore, the authorities have abundant

resulted in margin compression and companies’ profits. This

capacity to stimulate the economy via fiscal and/or monetary

could have negative implications on employment and wage

easing. Hence a sharp depreciation in the currency to

growth. Weak wage growth will be headwinds to the State

stimulate exports and inflate the economy is likely to be the

Council’s objective of shifting the economy towards a

last tool used. Last but not least, China still has sizeable

consumption model. For more details, please refer to our

external surpluses and huge FX reserves, enabling it to

China Watch – A closer look at China’s currency moves,

prevent disorderly yuan depreciation and/or speculation that

published on 13 August.

the weakness in the yuan is a one way bet. Indeed there were market talks that the central bank intervened in the onshore

…and to facilitate the take-up in the SDR basket…

yuan market on 12 August to calm the bearish sentiment in the

In addition, a more market based daily reference rate

currency.

mechanism will help China to get the yuan included in the IMF SDR basket. The IMF recently indicated that the decision to

A positive step towards more market based reference rate

include the yuan in the SDR basket may well be postponed to

In our view, the recent adjustment on the yuan reference rate

next year. Ahead of this decision, it is likely that Chinese

is a positive step. The People’s Bank of China (PBoC) stated

authorities will further accelerate financial liberalisation. We still

that an improvement in the central parity quotation will help

expect the yuan trading band to be widened from +/-2% to +/-

reduce distortion and move the reference rate closer towards

3% later this year as China seeks a more flexible exchange

the equilibrium market rate. Nevertheless it will take some time

rate regime. The trading band is likely to be widened only

for market makers to adjust quotation and trading practices to

when volatility in the yuan comes down and the gap between

find the equilibrium price in the yuan. There has been

the onshore trading spot rate and the yuan reference rate

encouraging signs that this is materializing. Before the new

narrows.

yuan reference rate pricing mechanism was implemented on 11 August, the onshore yuan spot rate was trading consistently around 1.5% discount to the reference rate. On 13 August, the

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EM FX Weekly - Change in China’s FX reg gime - 13 Augu ust 2015

ons shore yuan spo ot rate was trad ding close to pa ar to the

Bo ox 2: Market reaction r after P PBoC raised reference r rate e

refe erence rate, at the time of wriiting.

On 11 August, th he People’s Baank of China (P PBoC) raised th he yu uan onshore reference rate byy almost 2%, th he largest single

nd forecasts fo or USD/CNY: 6.55 6 (2015) an nd Our new year-en

da ay move in 20 years. y This was as a surprise to financial markkets.

75 (2016) respe ectively 6.7

Th he onshore yua an declined to 66.33 against th he USD, the

As elaborated abo ove, there are arguments for a weaker yuan n,

we eakest level sin nce the third quuarter of 2012. The move in the t

ough it is not exxpected that the e recent pace of o depreciation n tho

offfshore yuan (C CNH) was moree aggressive, sliding s to 6.43. As

will continue. As ssuch we expecct the onshore yuan y (CNY) to

a result the CNH H discount to thhe CNY was at the widest leve el in

dec cline to 6.50 an nd 6.55 in the third and last quarter of this

almost four years. Both the delliverable CNH forwards and nonn

yea ar respectively.. This would im mply a 6% depreciation this

de eliverable forwa ards (CNY NDF F) surged, refle ecting yuan

yea ar. Looking ahe ead we expect the CNY to de epreciate by a

de epreciation exp pectations. Thee options marke et demand to

e of 3% to 6.75 smaller magnitude 5 in 2016.

he edge weakness s in both the onnshore and offs shore yuan alsso ro ose by 300%. One O month volaatility expectatio ons in the yuan n

NH discount to o the CNY expected to narro ow CN

als so surged by nine n fold.

As the offshore yu uan (CNH) is more m exposed to t global marke et ces, the CNH iss more volatile e and tends to trade t at a forc discount during pe eriods of risk aversion a arising g from externall or dom mestic events. During the pea ak of the Europ pean debt crisiss in 2011, 2 the CNH discount to the e CNY widened to more than n 120 00 pips. Howevver as global se entiment impro oved and liquid dity

Bo ox 3: One off adjustment? a Th he PBoC tried to t calm markett fears by statin ng that the de evaluation of th he yuan referennce rate is a on ne-off adjustme ent wh hich will improv ve the pricing m mechanism for fixing and sho ould

in the CNH deepe ens, the averag ge daily variatio on between the e

no ot be interprete ed as a sign thaat the yuan will enter a

CN NH and CNY na arrowed to arou und 10 pips sin nce 2012 as

de epreciation tren nd. However ass the yuan clos sing rate on 11

arb bitrage opportunities take placce. Hence, alth hough a clear

Au ugust was about 1.5% from thhe central paritty on 11 Augusst,

discount in the CN NH is likely to persist p in the co oming weeks, w we

the yuan referen nce rate was fixxed weaker by 1.6% the

pect the CNH to o trade close to o the CNY late er this year. As exp

su ubsequent day on 12 August tto reflect dema and and supplyy

fina ancial markets have not fully priced in that th he Fed will raisse

co ondition in the foreign f exchannge market and d exchange rate e

the e Fed funds targ get rate by 25b bp in Septembe er, in our view,

movement of ma ajor currencies . On 13 Augus st, the yuan

we expect the CN NH to trade at a discount to th he CNY well intto

re eference rate was w raised by 1..1% after the yuan y closed 0.9 9%

ptember. Our 2 2015 Q3 USD/C CNH target is 6.55.

6 This is Sep

we eaker from cen ntral parity on 112 August.

higher than what the CNH forwa ards market are e currently cing in. Looking g ahead, we exxpect the USD//CNH to trade pric clos ser to our USD D/CNY forecastts in subsequent quarters.

ABN AMRO emerging maarket currenc cy forecasts 133-Aug 6.42 6.45 65 1,174 1.40 35.18 32.14 1 13,770 64 2.78 12.75 4.18 27.50 311 3.48 16.26 684

Q3 2015 Q4 2015 6.50 6.55 6.55 6.55 65 65 1,180 1 1,200 1.42 1.40 35.40 3 35.70 32.00 3 32.50 13,700 144,000 50 52 2.85 2.85 12.20 1 12.20 3.90 3.95 27.50 2 27.50 320 315 3.60 3.50 1 15.50 15.50 630 630

sho own their deterrmination to ke eep the onshorre yuan referen nce

US SD/CNY (onshore) US SD/CNH (offshore) US SD/INR US SD/KRW US SD/SGD US SD/THB US SD/TWD US SD/IDR US SD/RUB US SD/TRY US SD/ZAR EU UR/PLN EU UR/CZK EU UR/HUF US SD/BRL US SD/MXN US SD/CLP

rate e steady in subsequent mon nths, we scaled d down our yu uan

So ource: ABN AMRO O Group Economiccs

Box 1: Recap on n recent views s on the CNY Earrlier this year in n February, we e published a FX F Watch – Mo ore bea arish on the Chinese yuan (C CNY). We argu ued that Chine ese autthorities should allow a weaker w onsho ore yuan (CN NY) refe erence rate to support the economy. e In ad ddition we statted tha at the currency trading band will w widen this year y and the CN NY is likely to trade o on the weakerr side of the tra ading band. Ass a res sult the CNY iss expected to decline to 6.35 5 against the U US dollar later this yyear. However as Chinese authorities ha ave

dep preciation foreccast to 6.30.

Q1 2016 6.60 6.60 65 1,210 1.43 35.80 32.60 14,100 48 2.85 12.20 3.85 27.40 320 3.60 15.25 635

Q22 2016 6.65 6.65 66 1,230 1.45 36.00 32.80 14,400 47 2.85 12.20 3.85 27.25 325 3.55 15.25 640

Q3 2016 6.70 6.70 66 1,240 1.47 36.30 32.90 14,600 46 2.85 12.20 3.85 27.00 325 3.55 15.00 645

Q 2016 Q4 6.75 6.75 66 1,250 1.48 36.70 33.00 14,700 45 2.85 12.20 3.85 26.75 330 3.50 15.00 650

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EM FX Weekly - Change in China’s FX reg gime - 13 Augu ust 2015

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