Extract from our "Chinese RMB: No Step Deval, but Depreciation Nevertheless" research paper, published on the 17 February, 2016. Register for a free trial* to access the full paper.
Governor Zhou’s interview with Caixin (a financial magazine in China) on February 13, 2016, was an important communications effort by Governor Zhou, who had been silent for a few months. Since the Governor addressed several important matters related to the RMB, we comment on his statements in this note, and take the opportunity to reaffirm our thesis on the RMB. (1) There will be no one-off step adjustment in the RMB, similar to what the SNB did with the CHF. (2) Over time, supply-side reforms will form the key pillars of the policies of the Xi-Li Administration. Demand management and currency interventions are the ‘waves’ but reforms will be the ‘tide.’ (3) RMB is still over-valued, and some adjustment/correction is appropriate and unavoidable. We believe the RMB index is around 12% over-valued. (4) The PBOC has a pragmatic and not a dogmatic approach to the RMB basket, which will be refined and allowed to evolve to better reflect the changes in the economic fundamentals. The CFETS index is merely a starting point and not etched in stone. We believe the best benchmark to keep in mind is Singapore’s NEER regime. (5) Beijing does not wish to impose new capital controls, because that would be inconsistent with its medium-term plans for further financial sector reforms. But the enforcement of existing legal and regulatory restrictions will be enhanced. We believe China will continue to lose large sums of foreign reserves, due in large part to the pent-up demand for the private sector to diversify outside China. In sum, we find Governor Zhou’s comments in this interview sensible, pragmatic and realistic. They are broadly consistent with the thesis we’ve had on the RMB, that it should depreciate against the dollar, but perhaps not significantly so against the basket. We continue to believe that a 10-15% depreciation in the RMB against the dollar over the coming 12 months seems to be very reasonable an expectation, even if there’s temporary stability in USDRMB.
The full report contains the following sections:
- One-off step devaluation versus gradualism
- Capital outflows versus capital fight
- Capital controls will be avoided, as much as possible
- Belly of the distribution and tails
- Bottom line
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