Summary. The RMB continues to depreciate against the dollar. While there are a number of factors

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Stewart Cain
5 years ago
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1 Summary Editor: Tristan Zhuo Senior Economist Phone: The protectionist rhetoric of U.S. President-elect Trump during his campaign has prompted fears of escalation in trade disputes between China and the U.S. However, given the importance of bilateral trade between the two biggest economies in the world, Sino-U.S. relation is unlikely to suffer much, if at all, under a Trump administration. The RMB continues to depreciate against the dollar. While there are a number of factors Bank of China (Hong Kong) is a leading commercial banking group in Hong Kong by assets & customer deposits. BOCHK and its subsidiaries offer a comprehensive range of financial products and services to individual and corporate customers. BOCHK is one of the three note-issuing banks as well as the sole RMB clearing bank in Hong Kong. determining foreign exchange rates, it is just as likely that recent weakness is an overdue correction to the RMB being held steady when the dollar appreciated strongly against virtually all major currencies. So long as the dollar remains buoyant, the RMB s exchange rate will continue to be pressured. China s red hot property market has all but ruled out any interest rate cuts. Reductions in the reserve requirements ratio, currently at 17%, have also become unlikely, as policymakers are unwilling to risk further inflating housing prices.

2 Macro economy China s economic fundamentals remain largely stable, with GDP growing at 6.7% on a year-over-year basis in each of the first three quarters. The so-called L-shaped pattern has now been firmly established. The last time the Chinese economy grew at a double-digit pace was in From the first quarter of 2010 to the third quarter of 2012, quarterly growth on a year-on-year basis declined sharply from 12.2% to 7.5% in 11 quarters. In contrast, during the 16 quarters afterwards, the deceleration became a lot more moderate, with growth weakening only mildly from 7.5% to 6.7% in four years. Services are now China s main engine of growth. For the first three quarters as a whole, services accounted for 52.8% of GDP and grew 7.6%. This restructuring is crucial to keeping a lid on unemployment as growth slows. As services tend to be more labor-intensive than is manufacturing, for the same amount of output, more labor will be employed in a services-led than a manufacturing-led economy. This transformation, along with a shrinking workforce, has repudiated the claim that China must keep growing above a certain threshold to avoid mass unemployment. Throughout the first ten months of the year, the dynamics of the Chinese economy were fairly consistent. Positive developments include robust retail sales and stable industrial production, while headwinds mainly came from weak private fixed asset investment and very sluggish international trade. These fundamentals are unlikely to be reversed in the near future. Indeed, uncertainties have shifted to the policy implications of U.S. President-elect Trump. During his campaign, China was one of the main targets of Trump s criticism of unfair trade. However, for a number of reasons, Sino-U.S. trade is unlikely to deteriorate significantly. First, China does not meet the U.S. treasury s own conditions of a currency manipulator. Therefore, it would be difficult to justify slapping punitive tariffs on all Chinese exports. Second, given the reliance of the American consumer on Chinese imports, targeting Chinese-made goods will boost prices American households have to pay. Inflation will immediately soar. Third, most signs after the election suggest that Trump will attempt to govern in a pragmatic manner. Last but not least, trade relations between China and the U.S. have always been a bit bumpy. Even under the Obama administration, Chinese exports in various industries were hit with anti-dumping charges. China will have to cope with weak external demand for the foreseeable future. But hopefully, protectionist rhetoric will not turn into actions that threaten to compound the problem. 2

3 Monetary policy One-year benchmark deposit and lending rates are currently at 1.5% and 4.35%, respectively. Meanwhile, the reserve requirement ratio (RRR) is still at a fairly elevated 17%. Looking ahead, RRR cuts should be a preferred measure of monetary accommodation, as the two main policy tools are currently in vastly different positions. While benchmark interest rates have been cut to the lowest levels in decades, RRR s are still very high by historical standards. That being said, the frothiness of the real estate market in major Chinese cities has made RRR cuts in the near future very unlikely as policymakers will not risk further inflating housing prices. Currency rate As for China s currency, depreciation pressure against the dollar persists. However, in stark contrast to heightened volatility in the third and fourth quarters of last year, market participants have largely adapted to the current exchange rate regime. As of November 24 th, onshore RMB depreciated 6.1% year to date against the dollar, while offshore RMB was down 5.5%. The RMB s weakness against the dollar cannot be easily explained. In terms of economic fundamentals, growth momentum of the Chinese economy has largely stabilized. Meanwhile, in spite of slowing exports, trade surplus remains elevated. As for the direction of monetary policy, benchmark interest rates most likely have already bottomed. The dollar itself began to appreciate strongly in the mid From July, 2014 to the RMB s exchange rate mechanism reform on August 11, 2015, the dollar, as measured by the Bloomberg dollar index, rose by over 20%. However, during this period, the RMB hardly budged at all against the greenback. In other words, almost in lockstep with the dollar, the RMB appreciated considerably against other major currencies. That pattern was reversed by the 8.11 reform, after which the exact opposite happened. From August 11, 2015 to the eve of the U.S. election, the dollar was largely unchanged but rose by about 10% against the RMB. Therefore, an alternative, and probably somewhat simplified, explanation of recent RMB weakness in spite of benign fundamentals is that it is an overdue correction. More recently, the momentous Trump victory has propelled the dollar to new heights against its peers. The RMB also depreciated consistently and notably against the greenback. Nevertheless, it is important to put the RMB s performance in perspective. Both onshore and offshore RMB have declined nearly 2% against the dollar since the election. Nonetheless, due to the dollar s remarkable strength, 2% depreciation actually put the RMB near the top of 3

4 major currencies ranking. Equities China s equity market has become a lot less volatile in recent months, yet downward pressure has yet to recede. Accommodative monetary conditions may support valuations on the margin but will not provide stock prices with a significant boost for two reasons. For one, interest rate cuts have been all but ruled out. For another, as funds outstanding for foreign exchange keeps dwindling, liquidity will be somewhat constrained. As of November 24 st, the Shanghai Composite was down 8.4% year to date. The Shenzhen HK Connect will likely be launched by the end of the year. There will be a daily limit on net buying, but there will not be any aggregate quota. Meanwhile, the aggregate limit on the Shanghai HK Connect has been abolished. The Shenzhen HK Connect marks another major milestone in the internationalization of the RMB and China s capital account opening. Nevertheless, easier access to Hong Kong and mainland markets, for domestic and international investors, respectively, will not necessarily result in rising equities. At the time of the debut of the Shenzhen HK Connect, its Shanghai counterpart will have been in operation for about two years. Yet the Shanghai Composite and the Shenzhen Component indices have almost been moving in lockstep ever since That said, the small and medium enterprises listed in Shenzhen have far outperformed the major indices. The Shenzhen bourse is home to many of China s so-called new economy stocks, which should attract plenty of interest from international investors. Offshore RMB In September, RMB deposits amounted to billion Yuan, about a third lower than over 1 trillion Yuan in December, A shrinking capital pool could hinder the growth of the offshore market. In Hong Kong, there is no denying that the popularity of the RMB still largely hinges upon the currency s value against the dollar. The RMB s depreciation against the Hong Kong dollar has clearly dampened investors enthusiasm in holding RMB deposits. Unless investor sentiment of the currency s exchange rate improves markedly, a meaningful rebound of the capital pool will remain elusive. 4

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Summary. The RMB will be added to the IMF s SDR basket of currencies starting October 1 st, which will be

Summary. The RMB will be added to the IMF s SDR basket of currencies starting October 1 st, which will be Summary Editor: Tristan Zhuo Senior Economist Phone: +852 2826 6193 Email: tristanzhuo@bochk.com China s economic momentum strengthened somewhat in the month of August. Industrial production has largely