CNY: Band Widening Does It Matter This Time?

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1 Global FX Research & Strategy August 8, 2017 FX Flash CNY: Band Widening Does It Matter This Time? Does Band Widening Matter? There has been plenty speculation of band-widening since mid-jul. The editorials from onshore Financial News has urged for further FX reforms including CNY band widening. PBOC advisor Huang Yiping also called for greater CNY flexibility and reduced FX intervention. PBOC Assistant Governor Zhang Xiaohui (31 Jul) also stated in China Finance that the country will allow market to play decisive role in exchange rate mechanism, to firmly push forward exchange rate liberalisation reform. Before that was released, PBOC also issued a statement (25 Jul) and amongst the priorities that the central bank has listed, one of which was to steadily promote yuan internationalization. These statements fuelled speculation that the yuan trading band will be widened from the current +/-2% from reference rate to +/-3% before the 19 th National Congress of the Communist Party of China (CPC) in November. Band widening did matter in the Past In the past, the widening of the yuan trading band from +/-0.5% to +/-1.0% in 2012 and then to +/-2.0% in 2014 were followed by immediate yuan weakness and volatility as seen in Chart 1. Analysts Saktiandi Supaat (65) saktiandi@maybank.com.sg Fiona Lim (65) fionalim@maybank.com.sg Leslie Tang (65) leslietang@maybank.com.sg Christopher Wong (65) wongkl@maybank.com.sg Chart 1: Past FX Reforms Including Trading Band Widening Were Followed by Immediate Yuan Weakness and Volatility CNY Fixings Band High Band Low CNY Spot Apr Band Widening to +/-1% 17 Mar Band Widening to +/-2% 11 Aug CNY Fixing Revamped Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 SEE PAGE 5 FOR IMPORTANT DISCLOSURES

2 But Maybe Not This Time We are in a different era now. CNY is under less depreciation pressure in an environment of weak USD. Hopes for a 3 rd Fed hike for 2017 stands at a mere 38%, capping treasury yields and China still has a very controlled capital account. From Chart 1, the change in the CNY central parity fixing methodology in Aug 2015 has kept USDCNY spot away from the top +2% bound and lower -2% bound. Hence, the upper and lower bounds of the trading band is clearly, not tested. In addition, the introduction of the countercyclical adjustment factor has seen the CNY biased to the strong side against its major trading partners. China seems to be not only conscious of the yuan s performance against the USD. Now that USD is no longer threatening, China wants its yuan to stabilize against its trading basket. In fact, the CFETS RMB index has bounced off its near 92.0-lows since May (22.4% weighted against the USD, 16.34% weighted against the EUR). Chart 2: CFETS RMB Index Bounced Off Its Lows At 92.0 CFETS RMB Index Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Chart 3: PBOC Has to Ensure That The Yuan Does Not Weaken Excessively Against the EUR CNY Gain/Loss Vs. Major Trading Partners (%) USD EUR JPY KRW AUD HKD MYR SGD GBP THB Note: The gains/losses are calculated between 25 May 2017 to 8 Aug (today). In order to keep the RMB basket somewhat stable, CNY was prevented from weakening excessively against other major trading partners in the CFETS Index August 8,

3 such as the EUR that has been one of the strongest performing currency of the year. With the Countercyclical Adjustment Factor, CNY was able to limit its depreciation against the EUR to just 2.8% since 25 May It is ranked the second most resilient Asian currencies vs. the EUR amongst Asian peers on Chart 4 (b). This is an improvement from how it has performed since the start of the year to 25 May 2017 where it depreciated 5.7% vs. the EUR, ranked 10 th amongst its peers. Chart 4(a and b): CNY Has Stabilized Vs. the EUR Since the Introduction of the Countercyclical Adjustment Factor Gains/Losses VS. the EUR (2-Jan - 25 May 2017 in %) HKD PHP CNY IDR CNH SGD MYR THB JPY INR TWD KRW Gains/Losses Vs. The EUR (25 May - 8 Aug 2017 in %) PHP KRW HKD TWD MYR IDR JPY INR SGD CNH CNY THB Clearly, China has its currency under control at this time and it is also able to do so with ease in an environment of weak USD. In addition, FX Reserves have just registered the sixth consecutive month of increase, aided by interest in the bond connect that started in Jul, capital controls, strong growth momentum in 1H 2017 and a generally buoyant renminbi. In addition, recent investigations and punitive measures on firms acquiring overseas assets also likely discouraged further overseas direct investment. So basically, PBOC is in an ideal environment to pursue yuan liberalization. The band widening can happen but with the current external environment and with so much control in place, this is unlikely to spur a lot of volatility in the USDCNY like what it did in previous episodes. In fact, it could even be a nonevent unless the external environment turns bullish for the USD Fed becomes more aggressive in tightening, financial conditions tightened because the balance sheet reduction raises UST yields more than expected or simply Trump has started to get his administration working effectively on financial deregulation and infrastructure rebuilding. That kind of environment may see more CNY volatility and given a trading band of +/-3% around the central parity, could provide more room for yuan weakness. That said, bear in mind, even in a strong USD environment since 2015 Aug, USDCNY hardly tested the bounds of the 2% trading band. August 8,

4 Our Forecasts End Q3-17 End Q4-17 End Q1-18 End Q2-18 USDCNY USDCNH SGDCNY SGDCNH MYRCNY MYRCNH August 8,

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