FX Watch
Group Economics Macro & Financial Markets Research
28 November 2016
Asian FX: Leg down in 2017; to recover in 2018 Roy Teo Senior FX Strategist Tel: +65 6597 8616 roy.teo@sg.abnamro.com
Weakness of Asian currencies likely to persist in 2017…
…before recovering in 2018
Higher US Treasury yields and risk of more restrictive US trade policies: SGD most vulnerable, INR least
Arjen van Dijkhuizen Senior Economist Tel: +31 20 628 8052 arjen.van.dijkhuizen @nl.abnamro.com
China unlikely to be labelled a currency manipulator
2017 and 2018 year end USD/CNY forecasts: 7.15 and 7.10
Asian currencies underperformance to persist in 2017 but to recover in 2018 Asian currencies have declined by 1-3% since the US presidential elections on 8 November. A combination of higher US Treasury yields and concerns that the new US Administration will implement more restrictive trade policies have weighed on Asian currencies. The South Korean won has been the worst performer, declining by about 3% versus USD due to political uncertainty (impeachment of South Korea’s President as early as first two weeks of December 2016). In addition foreign capital inflows into domestic equity and bond markets year to date were at higher levels compared to in previous years. Hence a reversal of capital flows weighed on the won. Looking ahead, we expect weakness in Asian currencies to persist in 2017 but gradually fade in 2018. The latter is due to a less favorable outlook on the US dollar in 2018 and Asian central banks shifting towards a tighter monetary policy bias that year. Higher US yields impact: SGD and CNH most vulnerable; INR and KRW least Donald Trump’s surprising election victory has triggered a further rise of bond yields in the US and other advanced economies. We expect the Fed to hike policy rates by a cumulative 150 bps between December 2016 and late 2018 and we expect the US 10 yr yield to rise to 2.90% late-2017. Compared to our pre-Trump-scenario, these movements will likely negatively impact capital flows into emerging markets, including into emerging Asia. This will pose headwinds for economic growth and drive Asian FX lower versus the US dollar. Our sensitivity analysis (correlation, beta and coefficient of determination) show that the Singapore dollar and Chinese yuan are most vulnerable to firmer yields in the US. On the other hand, the Indian rupee and South Korean won are more resilient.
Insights.abnamro.nl/en
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FX Watch – Asian FX: Leg down in 2017; to recover in 2018 28 November 2016
SGD and CNH more vulnerable to firmer US yields
Exports to US % domestic GDP in 2015
Average weekly correlation and beta in 2016 with USD as base quotation
%
16
0.4
7
0.3
6
0.3
5
0.2
4
0.2
3
0.1
2
0.1
1
2
0.0
0
0
INR
KRW
TWD Beta (rhs)
Source: Bloomberg
IDR
THB
SGD
CNH
14
12 10 8 6 4
TW
ID
IN
CN
KR
TH
SG
HK
Exports to US % GDP
Corr (lhs) Source: IMF, World Bank
Trade protectionism: SGD and HKD most vulnerable; INR, IDR and TWD least It is highly uncertain to what extent US President elect Trump will implement trade protectionism measures next year. Our base case scenario is that measures taken if any, are unlikely to be extreme and more ‘watered down’ compared to his elections campaign promises. Nevertheless, we assess which currencies are likely to be more exposed to such potential measures. Based on 2015 data from the IMF, the US accounts a for larger share of total exports from China (18%), India (15%) and South Korea (13%). However when we take into account how open Asian economies are (exports as a percentage of GDP), we conclude that the Singapore and Hong Kong dollars are more vulnerable followed by the Thai baht and South Korean won. Both the Indian rupee and Indonesian rupiah are less vulnerable given that both economies are more driven by demand, while Taiwan exports are more concentrated towards China. Asian economies in a better shape to withstand depreciation pressures Before getting too gloomy about potential depreciation prospects for Asian currencies, it is worth highlighting that Asian economies are in a better shape to withstand potential depreciation pressures from external forces. Asian economies’ current account balances are generally healthier than other EM. Most Asian economies continue to enjoy current account surpluses, while both Indonesia and India’s current account deficit have narrowed substantially. Though some countries’ foreign currency reserves have declined in recent years, the import cover (FX reserves/monthly imports) is at healthier levels partly due to weaker domestic demand. According to data from the BIS, Asian countries’ central government debt are mostly on fixed rate and the debt service ratio of private nonfinancial sector are not at elevated levels. Finally, fiscal stimulus to support the economy and domestic currency remains a viable tool for most Asian economies, as unlike many advanced economies, fiscal space in most countries is still substantial. Please also see our Asia outlook – Pretty resilient to ‘Trump risks’. Overall, we are most bearish on the Singapore dollar given that it is most vulnerable to firmer yields in the US and potential trade protectionism. Though the Indian rupee is expected to be most resilient, we expect the Reserve Bank of India to keep the rupee stable against the currencies of India’s main trading partners, a feat which has been achieved since the third quarter of 2015.
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FX Watch – Asian FX: Leg down in 2017; to recover in 2018 28 November 2016
China, S Korea, Taiwan in US Treasury Monitoring list – unlikely to be labelled currency manipulator We do not expect the US to label China, South Korea or Taiwan as currency manipulators at short notice, for several reasons. The IMF has recently stated that the yuan is no longer undervalued. Indeed the Chinese yuan has strengthened by almost 20% against a basket of the currencies of its main trading partners since the yuan was de-pegged from the US dollar in the middle of 2010. The yuan inclusion in the SDR basket is also a signal of acceptance from the international community. In addition, under its existing framework, the US Treasury has also not labelled China a currency manipulator, noting that China’s current account surplus has narrowed from 3% of GDP in 2015 to 2.4% for the four quarters through June 2016. The US Treasury has acknowledged that policy makers in China have been intervening in the currency market to support the yuan (rather than to weaken it) to prevent a rapid depreciation which would have negative consequences for the Chinese and global economies. Last but not least, a retaliation from China remains a possibility given that the Communist Party holds its 19 th Congress next year, a politically sensitive period. Separately, though the South Korean won and Taiwan dollar are assessed to be undervalued by the IMF, we expect interventions by central banks in the coming year to be aimed at limiting depreciation pressures of domestic currencies rather than resisting appreciation. However, uncertainties on this front clearly remain, and public statements by the US president-elect or other officials may trigger turmoil on FX markets from time to time. Chinese yuan: slower pace of depreciation in 2017 We have revised our 2016 year end USD/CNY forecast from 6.80 to 6.90. This would imply a 6% depreciation versus the US dollar in 2016 after a 5% depreciation last year. In 2017, we expect a more moderate depreciation path of around 4% as economic stability, including in the exchange rate, is a priority as the Communist Party holds its 19th Congress, a politically sensitive period. China’s capital outflows are likely to decline as we expect economic growth to cool only marginally, from 6.7% in 2016 to 6.5% next year (see our latest China Watch – Soft landing to continue in 2017-18). The inflation outlook in both consumer and producer prices has also improved, reducing the need for broad monetary stimulus (targeted fiscal stimulus will likely remain the preferred tool, next to the addition of liquidity through regular and special central bank facilities).
China foreign currency liabilities have declined
Exchange rate stability a priority since 2016 H2
CNY bn
CNY index level
200
107 105
100
103
0
101
-100
99 97
-200 -300 Jan-10
95
Jul-11
Jan-13
Jul-14
Jan-16
93 Dec-14
Jun-15
China foreign currency bank loans flow CNYbn Source: PBOC
Dec-15 CNY Index
Source: CFETS, ABN AMRO
Jun-16
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FX Watch – Asian FX: Leg down in 2017; to recover in 2018 28 November 2016
In addition, China’s foreign currency liabilities have declined and foreign inflows into the domestic bond market are likely to increase moderately after the yuan inclusion into the SDR basket and increased accessibility of domestic markets to international investors. Policies to tackle excess capacity and high corporate debt (mostly domestic currency denominated debt) have commenced, though implementation risks remain. 2017 and 2018 USD/CNY forecasts: 7.15 and 7.0 respectively Our 2017 year end USD/CNY forecast of 7.15 is slightly more bearish than what is implied by non-deliverable forward market (1 year USD/CNY NDF market implying a rate of 7.11). This is partly due to the fact that we expect the Fed to tighten monetary policy by 75bp next year compared to 50bp priced in by financial markets. In 2018, we expect the yuan to recover against the US dollar, in line with the direction of Asian currencies. However the yuan is expected to underperform against currencies of China’s main trading partners given our view that economic growth is still likely to trend lower (we expect China’s growth to fall to 6% in 2018) and the restructuring of local corporate debt to persist. Our forecasts imply that the effective yuan exchange rate is projected to remain steady in 2017 but decline by about 5% in 2018 against currencies of China’s main trading partners.
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FX Watch – Asian FX: Leg down in 2017; to recover in 2018 28 November 2016
ABN AMRO Asian currency forecasts
USD/CNY (onshore) USD/CNH (offshore) USD/INR USD/KRW USD/SGD USD/THB USD/TWD USD/IDR
24-Nov 6.92 6.94 68.7 1,180 1.43 35.66 31.93 13,558
Q4 2016 6.90 6.93 68.5 1,180 1.43 35.60 32.00 13,500
Q1 2017 6.95 7.00 69.0 1,190 1.45 35.70 32.20 13,600
Q2 2017 7.05 7.10 69.5 1,200 1.47 36.00 32.50 13,700
Q3 2017 7.10 7.13 70.0 1,210 1.49 36.50 32.70 13,800
Q4 2017 7.15 7.15 70.5 1,220 1.50 36.80 33.00 13,900
Q1 2018 7.18 7.20 71.0 1,230 1.52 37.00 33.20 14,000
Q2 2018 7.18 7.20 70.0 1,220 1.50 36.50 33.00 13,900
Q3 2018 7.15 7.15 69.0 1,200 1.45 36.00 32.50 13,700
Q4 2018 7.10 7.10 68.5 1180 1.43 35.60 32.00 13500
Source: ABN AMRO Group Economics
Find out more about Group Economics at: https://insights.abnamro.nl/en/
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FX Watch – Asian FX: Leg down in 2017; to recover in 2018 28 November 2016