The current depreciation trend of the RMB against USD should be seen as a broad-based depreciation of the RMB and not bilaterally to the USD. The trend started from the second week of November 2015, and it is clear that the move was planned well ahead and engineered in a streamline fashion. We see the adoption of a weak FX policy as a byproduct of the overall monetary policy easing by the PBOC that needs to be accelerated to support growth as well as the moribund stock market. This means that the weakening of the RMB will be managed in a "controlled" fashion to avoid a free fall, which explains why the regulators have suspended or tightened rules in some cross border FX activities such as the RQDII scheme and lending of RMB to offshore market.
Why we believe the RMB depreciation policy was a policy engineered in a controlled fashion can be seen in three major events in late 2015:
- 11 August: PBOC announced a change in its FX regime that sets the daily fixing of the RMB against USD and other foreign currencies for the onshore market. In the reformed regime, the PBOC would reference the previous day's market closing as well as gather market makers' quotes to set the daily fixing. The announcement came with a 1.9% devaluation of the RMB vs. USD on the day which was followed by two more days of weakening, amounting to a total of 4.7%. The PBOC subsequently said that the move was in line with market demand for RMB devaluation against USD and to address concern of a strong RMB on exports.
- 30 November: IMF announces RMB's inclusion into SDR basket, given weight of 10.92% to be effective on 1 October 2016.
- 11 December: PBOC announces a RMB Index which is a trade-weighted basket against 13 foreign currency components in which the USD was given a weight of 26.4%, EUR 21.4%, JPY 14.7%, HKD 6.6% and others. Using these weights, we have constructed the RMB Index. This is where we see that the RMB was initially devalued by 5% following the 11 August announcement, recovered partially (during the period of IMF's decision on the RMB's SDR inclusion) and resumed its depreciation from the second week of November. See Chart below which maps the RMB Index (green line joined to black line) against the DXY index and the MAS' official SGD NEER index.
RMB Index, DXY Index, SGD NEER Index Compared
Policymakers most likely have a target for how much the RMB would be allowed to weaken against a broad-based basket of currencies in the medium term e.g. 3-6 month horizon before it evaluates the desired impact on the economy and markets. Thus far, from its peak in early August, the RMB has already weakened by 5.6% against the basket. This brings the RMB back to the level where it started the year in 2015. We believe there will be a pause now but since the trend started from August, we would assume by February, policymakers have to decide again whether there is a need for further "controlled" depreciation of the RMB against this basket.
In our view, as the economic outlook remains nebulous, there is a better than 50% chance to see a further 3% depreciation of the RMB against its basket. During this interim, we expect measures taken to control the cross-border capital flows will remain in place, which will continue to place more pressure on the offshore CNH market vs. the onshore CNY market. The objective to converge the two currency markets would therefore be further delayed although a firm timeline to achieve this convergence is set by the IMF's target to effect the RMB's inclusion into the SDR basket by 1 October 2016. In other words, the PBOC has to stabilize the RMB FX market before this timeline. Allowing a deeper RMB depreciation to "over correct" itself may become a last resort if confidence is not restored by the end of Q3 2016.