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Renminbi rally stalls, momentarily?

The renminbi rallied strongly after my call on 22 May 2017 for it to strengthen.

The renminbi rallied strongly after my call on 22 May 2017 for it to strengthen.

Its rapid appreciation may have caught the People's Bank of China (PBoC) off guard. Having succeeded, after much effort, in dislodging the view that the renminbi could only depreciate, the last thing the PBoC needed was overblown expectations about the renminbi's capacity to appreciate.

So, to ensure the currency's current momentum did not lead to excessive appreciation and keep overall macro stability in the Chinese system, the PBoC acted to curb the renminbi’s appreciation pressure.

On 8 September 2017, the PBoC announced that it would:

  • (i) remove the requirement to set aside a 20% capital reserve for onshore financial institutions when buying foreign exchange forwards for clients (the rule was introduced on 15 October 2015 to reduce capital outflows)
  • (ii) scrap the reserve requirement for offshore banks’ interbank renminbi deposits held onshore (introduced on 15 July 2016 to deter offshore short-selling of renminbi using onshore funding).

These measures could take some of the dynamic out of the renminbi's strengthening momentum because they reduce the cost of hedging (and short-selling) the currency. The PBoC’s moves do nothing to change the fundamentally positive sentiment on the renminbi, just as they were ineffective in arresting the renminbi’s depreciation pressure when they were introduced (see Exhibit 1).

Exhibit 1: Changes in the renminbi/US dollar exchange rate (renminbi per US dollar) for the period from 10/08/2015 through 13/09/2017

renminbiSource: CEIC, BNP Paribas Asset Management (Asia), as of 13/09/2017

The renminbi’s recent strength (see Exhibit 4 below) has been a result of:

  1. the weakness of the US dollar in 2017
  2. sentiment towards China has improved following fading capital outflows and a disappearance of economic hard-landing fears as data has improved (e.g. China’s factories outperformed again in August as export orders expanded at the fastest rate in more than seven years, according to the Caixin-Markit manufacturing purchasing managers’ index, released on 01/09/17)
  3. MSCI's inclusion of some A-shares in its global emerging markets indices
  4. sales of foreign currencies held by onshore companies (Exhibit 2) as fears of a one-way trend in renminbi depreciation fade.

Exhibit 2: Onshore Chinese companies are tending to sell down their holdings of foreign currency - the graph shows the change in the ratio of onshore Chinese companies liquidating holdings of foreign currency relative to taking delivery of foreign currency

renminbiSource: CEIC, BNP Paribas Asset Management (Asia); as of 13/09/2017

From a policy perspective, the strength is a result of the PBoC’s foreign exchange policy shift since July to keep the offshore renminbi’s (CNY) trade-weighted exchange rate (approximated by the CFETS index) stable by using the CNY-USD cross-rate as an adjustment factor.* So when the CFETS index weakens, the PBoC lets the renminbi rise against the USD to pull up the trade-weighted exchange rate so that the CFETS index remains stable.  Conversely, when the CFETS index strengthens, the PBoC lets the renminbi fall against the USD to push down the trade-weighted exchange rate, so that the CFETS index remains stable.

Due to the change in foreign exchange policy, the decline of the CFETS index in the first half of 2017 has prompted the PBoC to let the renminbi rise against the US dollar sharply since July 2017 to reverse the weakness of the CFETS index, delivering more than 3% gains up until mid-September (Exhibit 3).

Exhibit 3: RMB trade-weighted exchange rate (CFETS) versus the offshore renminbi (CNY-USD) exchange raterenminbiSource: CEIC, BNP Paribas Asset Management (Asia), as of 13/09/2017

There is also a near-term political factor to consider. To prepare for this November's visit by US President Trump, Beijing may be allowing the renminbi to rise against the US dollar to soothe potential tensions that Trump may bring to the negotiation table over Sino-US trade.

What happens next will depend on the US dollar's direction and the PBoC’s foreign exchange policy. Since the PBoC's announcement on 8 September, the renminbi has weakened in the face of a US dollar rally. If, however, the US dollar were to revert to its previous weakening trend, then, ceteris paribus, the CFETS index would weaken again. And if the PBoC sticks to its exchange rate policy by targeting a stable CFETS index, it would let the renminbi rise further against the US dollar. At this stage, the market is expecting the PBoC to hold the CFETS index stable at the current level of around 95, implying further renminbi strength.

However, if the renminbi strengthens or weakens too fast and too much, the PBoC will likely intervene in foreign exchange markets to slow its movement and maintain relative stability.

So far, there has been no evidence of direct intervention. But the PBoC’s moves on 8 September 2017 to reverse the reserve requirements for financial institutions to buy foreign exchange have certainly had an effect in curbing the renminbi’s strength in the short term by reducing the cost of purchasing foreign currencies. These policy changes do not of course necessarily change the market's underlying sentiment. They do reflect the Chinese authorities’ improved confidence in the renminbi’s outlook and their effort to continue market liberalisation whenever the environment allows.

Last but not least, the market estimates that onshore companies are sitting on holdings of some USD 500 billion as a result of their hoarding of foreign currency between 2015 and 2016 when they feared a major renminbi depreciation.

Now that those fears have dissipated, they are starting to reduce these holdings. This should support the renminbi for a good while longer, especially if, in addition events conspire to improve sentiment on the renminbi.

Exhibit 4: The bigger picture - this year's rally erased its losses in 2016 - graph shows changes in the USD/renminbi exchange rate from 27/03/2015 through 25/09/2017

renminbiSource: Bloomberg, BNP Paribas Asset Management, as of 13/09/2017

Written on 25/09/2017

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Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

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