Markets more comfortable with RMB depreciation: From fear to acceptance

HONG KONG - A more transparent FX policy has helped alter the perception of RMB depreciation from fear to acceptance, HSBC says in a research note. The bank says the RMB's overvaluation is reducing but more weakness is likely, and it maintains its forecast of USD-RMB at 6.90 by the end of 2016. “FX outflows have slowed and are changing, reflecting China's rising role as a capital exporter,” HSBC says.

The bank notes that while the USD-CNY rate has been steadily creeping upwards since late May, reaching multi-year highs, the reaction in global markets to the RMB's depreciation appears much more subdued compared to earlier this year.
“This change in attitude - from 'fear' to 'acceptance' - towards RMB weakness is due to a number of factors. Firstly, China's FX policy has become more transparent. The USD-CNY fixing mechanism has become simpler to predict and this has eased concerns that China is trying to purposely weaken its currency.
“Secondly, capital outflow pressures have lessened somewhat. For example, the drop in China's FX reserves has slowed in recent months, which is a strong indication of not only a more hands-off approach to its FX policy, but also FX outflows being less intense.
“The underlying details of China's FX outflows suggest that domestic corporates are not repaying the USD liabilities as quickly. In fact, corporate FX borrowing could actually increase on the back of recently relaxed external debt regulations, as well as falling core bond yields.
“The exchange rate adjustment and the RMB's yield advantage may help to attract some foreign inflow over time, especially given China is opening the door to global central banks and real money investors.”
HSBC says the motivation for China's demand for FX will increasingly change, as corporates' overseas investments become larger. “In the longer-run, China's private sector ownership of foreign assets should make the RMB sounder. This process will help China evolve into a net capital exporter to the world.
“However, it is worth bearing in mind that concerns surrounding the RMB's depreciation could re-appear again if we see a return of disruptive USD strength or a significant deterioration in China's domestic growth outlook. In such a case, FX reforms could be temporarily suspended and/or slowed.
“It has long been our view that China's path towards greater exchange rate flexibility is not a straightforward one, but involves various "ease-then-squeeze" episodes - FX policy relaxing followed by leaning against speculative forces.”  www.hsbc.com (ATI).