Download GI Research Market Commentary Second CNY depreciation

GI Research Market Commentary
Second CNY depreciation explained by the new currency fixing method
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The reference rate for the Chinese currency was again fixed markedly lower against the US
dollar today.
However, this is basically the result of a fundamental reform of the exchange rate fixing
method. We do not regard this as the beginning of a currency war.
Over the short run, they may be strong volatility until markets have fully digested the new
fixing method.
While the currency may suffer a bit more near-term, we see a strong depreciation of the yuan
as less likely.
For the second day in a row, the reference rate for the Chinese currency was fixed markedly lower against
the US dollar, by 1.6% today after 1.9% yesterday. The yuan depreciated initially up to 6.4458 CNY/USD
today but reversed of late to 6.3837 CNY/USD.
Yesterday, the People’s Bank of China (PBoC) statement had initially suggested that the depreciation was a
one-off adjustment. However, over the course of the day it became increasingly clear that the statement
announced a more fundamental reform of the exchange rate fixing method, which gives markets movements
a much greater role. The statement in fact announced a new method of setting the daily fixing, which is now
based on the previous day’s closing rate “in conjunction with supply/demand and movements of other
currencies”.
Accordingly, today the PBoC said that the main reason for the lower reference rate is the previous day’s
movement in the spot market. Thus the move was basically no deliberate devaluation but a depreciation,
given the now higher currency flexibility. As a consequence, the IMF welcomed the new method, saying that
the greater exchange rate flexibility is important for China. Moreover, the slight appreciation of the yuan by
the end of the day lends hope to the idea that we will not see another strong move of the fixing rate
tomorrow.
In addition, the new method leaves room for enormous discretionary action of the PBoC. Demand and
supply factors are likely due to judgment by the central bank and the movement of other currencies makes
clear reference to a more trade weighted approach. While we acknowledge that the PBoC is likely under
huge pressures internally (by the Commerce Ministry) to help the business cycle by a more competitive
currency, we also see the costs of such action (see yesterday’s mail from Thomas Hempell). On the one
hand, exports dropped by 8.3% yoy in July, after some improvement in the previous month. Moreover, the
yuan so far was bound to appreciate with the US dollar, a development that would be likely to gather pace
with the first key rate hike in the US. China’s macro data of today came also in on the soft side. While retail
sales only decreased to a growth rate of 10.5% yoy, after 10.6% yoy in the previous month, industrial
production fell back in July to 6% yoy (about the level of May) and urban investment decreased to 11.2% yoy
ytd. Thus the stabilization signals of last month have vanished again, at least temporarily.
On the other hand, there are also strong arguments for the PBoC to use its room of discretion to prevent a
strong yuan depreciation, like the strategic exchange rate goals of an internationalization of the yuan, the
inclusion in the IMF’s SDR basket, the liberalization of China’s capital account and the rebalancing of the
economy towards a stronger role of consumption. Regarding the latter, it was encouraging that the latest
data show no major wealth effect from the recent stock market slump on private consumption.
Nevertheless, over the short run they may be strong volatility until markets have fully digested the new (more
flexible) fixing method of the Chinese currency. China’s stock markets have lost part of last week’s gains. In
Europe, stock markets fell back slightly below the previous trough of end of July on fears that a strong
depreciation of the yuan could dampen exports to China and indirectly, via increased competitiveness of
China, also to other countries. However, we consider a major depreciation of the yuan still as less likely and
also do not see China as engaging in a currency war.