U.S.-China tensions will chart the course for renminbi, says S&P report

August 7, 2019

SINGAPORE --The outlook for the Chinese renminbi will depend mainly on trade and technology tensions with the U.S., S&P Global Ratings said in a report published today, titled "China's Renminbi Moves Beyond 7".

S&P says the move of the renminbi through 7.00 is consistent with China's exchange rate policy framework of the last two years or so.

"The policy since 2016 has been to focus more on the stability of the currency versus the trade-weighted basket (in which the U.S. dollar has a 27% weight if we also include the pegged Hong Kong dollar) and allow market forces to play a greater role," the report says, adding that the obvious implication of such a policy is more volatility in the bilateral rate versus the dollar.

"We think China's renminbi policy framework is unchanged even though the timing of the USDCNY move above 7.00 raises eyebrows," said Shaun Roache, chief economist for Asia-Pacific at S&P Global Ratings.

"For some time, China has allowed more flexibility versus the dollar, and higher trade policy risks mean more depreciation pressure."

The timing of the move beyond 7.00 is clearly not a coincidence and may have a political dimension, the report says, pointing to "some evidence" that leading into trade negotiations with the U.S., the PBOC had been "leaning against the wind" to restrain depreciation. This had served to suppress volatility.

"While the timing may raise concerns that big currency policy changes are afoot, so far there is little evidence that the overall policy framework has changed, Roache says, noting that, "the USDCNY move of more than 2% since the U.S. trade policy shock is larger-than-average".

"However, knowing what we know now, perhaps this should not be a surprise," he says.

"First, we received unexpected news of a possible hike in U.S. tariffs. Second, markets repriced volatility as it became clear that renminbi risk was two-tailed around the 7.00 level (as it should be for any genuinely flexible currency)."

Roaches mays that renminbi depreciation can raise concerns about large capital outflows and financial instability but that S&P believes these risks are manageable.

"Of course, market expectations can be self-fulfilling and it is unwise to rule this out. Still, we would point to differences between crossing 7.00 now and the volatile period of 2015-2016, including a more stable economy, tighter capital flow measures, less pressure from offshore borrowers to retire dollar debt, and currency policy continuity rather than an unexpected regime change.

"The outlook for the renminbi will depend mainly on trade-tech tension but we do not expect a substantial depreciation.

"If the situation stabilises and global growth evolves as we expect, the renminbi should range trade around current levels versus the dollar and against the CFETS index.

"Before this most recent move, China's BOP was fairly balanced with little change in valuation-adjusted foreign exchange reserves, suggesting the renminbi was not substantially misaligned."

Roache says exchange rates across Asia-Pacific will face depreciation pressures if renminbi weakness persists, reflecting a new "renminbi bloc."

The dollar retains its importance for some currencies, he says, especially those associated with current-account deficit economies,  "but we see a very strong paradigm shift from being firmly in a "dollar bloc" to having higher sensitivity to movements in the renminbi".

This includes currencies such as the Australian dollar, the Korean won, and the Malaysian ringgit, he says.

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