EM FX Weekly – Delay in CNY liberalization?

by: Roy Teo , Arjen van Dijkhuizen

EM-FX-Weekly-9-July.pdf (143 KB)
  • Downside risks to China economic outlook – more monetary easing in pipeline
  • Markets pricing in larger depreciation in the yuan next year
  • Delay in exchange rate liberalization and CNY inclusion in SDR basket?
  • Asian currencies’ resilience – some bright spots



More China worries

The sharp decline in China’s equity markets, following an amazing rally, also poses downward risks for the economy. This could particularly work through confidence effects. Wealth effects might still play a limited role, as overall equity holdings are still relatively moderate in GDP terms (and Chinese equity markets are still one of the best-performing year-to-date). The sell-off might also lead to arise in non-performing loans and complicate the strategy to use equity issuance to reduce debt levels. All in all, although hard to estimate at this stage, the stock market crash has added further downside risks to the economic outlook. Next week, China’s Q2 GDP print will be crucial for market sentiment. Economic growth is expected to ease from 7% to 6.8% according to market consensus. We expect the People’s Bank of China to cut the benchmark rates further by 25bp and lower the reserve requirement ratio by an additional 50-100bp in the coming months to support the economy.

Pressure on CNY muted; depreciation expectations increasing

Despite the 30% decline in equity markets since the middle of June, the Chinese yuan (CNY) has remained relatively stable. We suspect that the central bank has been in the market to ease volatility in the exchange rate. Furthermore, the central bank has kept the yuan daily fix stable as they lean against market forces that a weaker yuan is a one way bet. Nevertheless, the options market demand to hedge volatility and depreciation in the yuan has increased slightly. The offshore non-deliverable forward market is also implying that Chinese authorities will be more tolerant in a weaker exchange rate next year after the IMF review on the CNY inclusion in the SDR basket later this year. We maintain our view that the yuan will decline towards 6.30 and 6.40 by the end of 2015 and 2016, respectively.

Delay in exchange rate liberalization and CNY inclusion in SDR basket?

At the time of writing, measures deployed by the Chinese authorities in recent days seem to have stabilized the equity market. Nevertheless, the recent sharp selloff in China equity markets has sparked criticism that the regulations and mechanisms to promote stable financial markets are not robust enough. Weakness in equity markets is likely to spark further capital outflows and pressure on the Chinese yuan. This may impede China’s intent and objective to speed up the capital account liberalization process. A wider trading band for the yuan could be delayed and intervention by the central bank to defend weakness in the yuan will continue. As a result, the probability that the yuan will be included in the SDR basket later this year has fallen

Asian currencies’ resilience – some bright spots

Asian currencies have continued their recent resilience despite continued worries surrounding Greece and China. We think that the possible fall-out from China would have a larger impact on Asian currencies than Greece. China growth concerns have pressured commodity prices. With the exception of Indonesia and Malaysia, Asian countries are net commodities importers. The decline in commodity prices should benefit most Asian economies’ terms of trade. India and Indonesia’s inflation outlook should also improve as a result of lower oil prices. Still, should the Chinese economy slow more than expected, that might also have negative spill-over effects to Asian economies and Asian currencies.