Kamakshya Trivedi, Research Analyst at Goldman Sachs, suggests that while CNY depreciation had further to run in support of China’s bumpy growth deceleration, it was unlikely to be a linear process, with bouts of depreciation followed by bouts of stable fixes.
Key Quotes
“We have now had a month where the fix has been stable or, if anything, on the strong side. Associated with that, $/CNH at or around the 6.54 level is now approximately 2.5% lower than peak levels in early January, a bit less than the nearly 3% appreciation between August and October last year. So we are approaching more favourable levels to reset hedges and regain exposure to $/China upside line with our 12-month forecast of 7.00 for $/CNY, especially once the G20 summit in Shanghai is in the rear-view mirror.
One pushback against this view is that China may see a cyclical upswing locally – fuelled by the credit surge in January – and the CNY may continue to strengthen in concert. We have some sympathy for the notion of a local cyclical upswing (even if it makes the eventual credit unwind that much worse), but weaker CNY fixes against the backdrop of stronger Chinese data may be less disruptive from a global markets standpoint and may bring about a larger trade-weighted depreciation.
Our 12-month $/CNY forecast is 7.00, corner solutions (8- handle or beyond on $/CNY) still some way off. A second pushback is that a managed and limited depreciation such as envisaged by our forecasts is likely to exacerbate capital outflow, and that a large one-off depreciation is more likely as the reserve drain becomes unsustainable.
We acknowledge that capital outflow pressures are endogenous to some extent, but equally it is hard to imagine that a large abrupt move would end capital outflow pressures. For now, we are likely to remain in the zone of interior solutions – where some degree of currency depreciation, some further reserve burn and some tightening of capital controls are all part of the policy mix – and we read the recent comments by PBoC governor Zhou pushing back against market expectations of sharp devaluations or a shuttering of the capital account as supportive of this path.
Of course, if capital outflow pressures and the reserve drain continue at the current pace for another 6-12 months, corner solutions including a sharp one-off devaluation become possible to envisage. What could such a sharp one-off devaluation look like? Using our FEER framework, we model a scenario that involves a domestic demand ‘hard landing’ and capital outflows that continue at the same pace as last year, but instead of reserve depletion or capital
controls, we assume that a larger current account surplus would be required (roughly 5% of GDP) to square the balance of payments.
The results imply a much more significant depreciation in CNY fair values versus the USD (pushing the $/CNY fair value towards an 8-handle and beyond, relative to a baseline of 6.1). The small open economies of Asia (Taiwan, Korea and Malaysia) see the most knock-on depreciation pressure (of about 20%), but we continue to regard these outcomes as risk rather than base-case scenarios.”
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