China: RMB depreciation to continue through 2017 - Nomura

Analysts at Nomura expect RMB depreciation to continue through 2017, supported by several factors and lists down those factors.

Key Quotes

“US political and Fed policy risks and global political uncertainty. Donald Trump as president and a Republican-led House would lead to a repricing of US inflation/Fed hike risks (partly from fiscal expansion concerns) and pressure broad USD/Asia higher. The combination of higher US rates and concerns over ECB/BOJ tapering reinforces our concerns over capital outflows from China and Asia via both portfolio flows and foreign currency loans. The other risk from President-elect Trump is the classification of China as a currency manipulator soon after his inauguration (20 January 2017) and the potential imposition of tariffs on imports from China. If tariffs are imposed, China could retaliate, as highlighted in the state-run Global Times (13 November 2016). Other global risk events to watch include elections in Europe, where support for anti-establishment parties has grown.”

“We still expect China to experience broad net capital outflows over the medium term, as reflected in consistent FX reserve declines (adjusted reserves down by USD28.6bn m-o-m in November and down USD441bn over the past 12 months). This has been driven primarily by locals diversifying into foreign assets, with China’s Q2 2016 private foreign assets amounting to a still relatively low 27.3% of GDP (around USD3trn), though up from 21.9% of GDP (USD2.1trn) in 2013. Outflows continue to be led primarily by FDI and services (Q3 deficits of USD31.4bn and USD69.5bn, respectively), while unaccounted outflows in the BoP’s errors and omissions remain large at USD49.9bn in Q2 (latest data). Overall, despite steady headline GDP growth data (forecast to continue into the October/November 2017 19th Party Congress), a pickup in trade-related inflows (settlement surplus at USD56.4bn in Q3) and net foreign portfolio inflows (USD12.2bn in Q3), China will likely continue to face net capital outflows over the medium term.” 

“Our latest FX valuation analysis shows that RMB is around 4.0% overvalued (average of our four models) and the objective of authorities to increase FX flexibility should support further medium-term RMB depreciation. Although there is likely to be sporadic FX USD-selling intervention to manage RMB depreciation expectations, the experience from August 2015 to January 2016 (adjusted FX reserves fell sharply by USD438bn or around 12% of total), suggests greater FX flexibility ahead and some avoidance of the “Impossible Trinity.””

“Our analysis shows there has been a bias on the CNY trade-weighted index (TWI), with the TWI stable when broad USD is strong and weaker when broad USD is soft. We observed that, when broad USD is strong, authorities often allow USD/CNY to move higher (with some FX management) to keep CNY CFETS relatively stable. When broad USD is soft, the authorities then allow the release of onshore USD demand pressures, which limits the fall in USD/CNY and leads to notable CNY CFETS weakness. As we analysed, net capital outflows add to the sustainability of this CNY TWI bias.”