articles Ratings /ratings/en/research/articles/190807-economic-research-china-s-renminbi-moves-beyond-7-11100616 content
Log in to other products

Login to Market Intelligence Platform

 /


Looking for more?

Request a Demo

You're one step closer to unlocking our suite of comprehensive and robust tools.

Fill out the form so we can connect you to the right person.

  • First Name*
  • Last Name*
  • Business Email *
  • Phone *
  • Company Name *
  • City *

* Required

In This List
COMMENTS

Economic Research: China's Renminbi Moves Beyond 7


Economic Research: China's Renminbi Moves Beyond 7

Markets like to draw lines in the sand and were always likely to react to the Chinese renminbi weakening beyond 7.00 to the U.S. dollar. Markets like round numbers and attach psychological importance to levels that are easy to remember. The belief among some market participants that policymakers in China were also wedded to certain levels may have added to the surprise element of the move above 7.00 for some.

In June, the governor of the People's Bank of China (PBOC) tried to disabuse some market participants of this notion. In an interview, Yi Gang noted, "I don't think along this mathematical scale, any number is more important than other numbers." He added that "There is obviously a link between the trade war and the movements of renminbi," and the bilateral exchange rate is "basically determined by supply and demand of the market force, so that it's basically a market mechanism."

With the governor's comments in mind, S&P Global Ratings believes the key fundamental that changed over the past week is the risk of higher U.S.-China trade and technology tensions. The move of the renminbi through 7.00 is consistent with China's exchange rate policy framework of the last two years or so. Put simply, 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 obvious implication of such a policy is more volatility in the bilateral rate versus the dollar.

A structural rise in USDCNY realized volatility is exactly what we have seen up until recently. As the exchange rate neared 7.00 and U.S.-China negotiations were scheduled, so realized and implied volatility began to fall (see chart 1).

Chart 1

image

The timing of the move beyond 7.00 is clearly not a coincidence and may have a political dimension. There was some evidence that leading into negotiations with the U.S., the PBOC had been "leaning against the wind" to restrain depreciation. The central bank does this by using the so-called "counter-cyclical buffer" to provide some discretion in setting the daily fixing of the onshore USDCNY rate. When the fix deviates a little more than usual from the rate implied by the market close and overnight FX movements, markets interpret this as a signal about PBOC preferences and possible intervention to prevent the currency from moving too fast. In recent months, this signaling had been consistent, pointing to a preference for stability close to, but not weaker, than 7.00. This also resulted in declining realized volatility.

While the timing may raise concerns that big currency policy changes are afoot, so far, we have not seen any evidence that the overall policy framework has changed. 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. 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)

The renminbi remains more stable against a trade-weighted basket of currencies (see chart 2). The renminbi is about 5% weaker than its strongest level since January 2018 versus the China Foreign Exchange Trading System index (or the CFETS index). This index was launched by CFETS (a subsidiary of the central bank) to help shift the anchor of expectations from the dollar to a broader range of currencies. Not a large move, and smaller than the 12% depreciation versus the strongest level versus the dollar over the same period.

Chart 2

image

Renminbi depreciation can raise concerns about large capital outflows and financial instability but we think 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:

  • Markets are less concerned about a hard landing in China. Activity data have stabilized in recent months and some moderate policy easing is still in the pipeline;
  • Policymakers are maintaining policy continuity rather than introducing a surprise regime change;
  • Property developers--China's largest offshore borrowers--face tighter onshore funding conditions, which means they are unlikely to rush to retire dollar debt; and
  • Tighter capital flow measures are largely working for now, although there remains some leakage from the balance of payments (BOP).

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

At the same time, we expect China to tolerate some flexibility because heavy-handed currency management often proves counterproductive. What appears to be stability--softly pegging the renminbi versus the dollar and suppressing volatility today--can in fact lead to abrupt changes and more volatility in the future. This problem became apparent even in the last few months as PBOC leaning against the wind encouraged markets to underprice the risk of a move above 7.00. Then, when a move subsequently occurs, the abrupt repricing of volatility causes a larger-than-average move and raises concerns about a policy regime change.

The implications for macroeconomic policies--so long as China avoids destabilizing capital outflow--are limited, in our view. Cyclically, depreciation will partially absorb the impact of tariffs, reducing the burden on other policies to support growth. Structurally, allowing more flexibility in the currency provides more space to set policies according to domestic objectives such as growth, inflation, and financial stability.

Exchange rates across Asia-Pacific will face depreciation pressures if renminbi weakness persists, consistent with our finding of a new "renminbi bloc." We presented evidence in our recent commentary ("APAC Economic Snapshots: Trade Wars And Currency Concerns," published on June 25, 2019) that the renminbi has become a more important influence on a range of Asian currencies, both in developed and emerging markets. The dollar retains its importance for some currencies, 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 reflects China's rising share in global trade and its emergence as a price setter rather than a price taker.

In turn, emerging market central banks in Asia-Pacific may show more caution in easing monetary policies given renminbi depreciation. Some economies fund their current account deficits in dollars or with bond portfolio inflows from exchange-rate sensitive investors. As currency volatility versus the dollar rises, so the risk premium on some emerging market assets will rise. As we have seen in Asia over recent years, central banks often take a cautious approach to cutting rates in such an environment.

This report does not constitute a rating action.

Asia-Pacific Chief Economist:Shaun Roache, Singapore (65) 6597-6137;
shaun.roache@spglobal.com
Asia-Pacific Economist:Vincent R Conti, Singapore + 65 6216 1188;
vincent.conti@spglobal.com
Vishrut Rana, Singapore (65) 6216-1008;
vishrut.rana@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: research_request@spglobal.com.


Register with S&P Global Ratings

Register now to access exclusive content, events, tools, and more.

Go Back