China’s central bank devalued its tightly controlled currency, causing its biggest one-day loss in two decades, as the world’s secondlargest economy continues to sputter. Chinese authorities said the change would help drive the currency toward more market-driven movements. The move also signalled the government’s growing worry about slow growth. A shift toward a weaker currency could help flagging exports at a time when many other efforts to boost the economy have not proven very effective. (Source: The Wall Street Journal)

Investment Highlights

- The devaluation yesterday was the most significant downward adjustment to the CNY since 1994. China has set a midpoint for the value of the CNY against the USD. In daily trading, the CNY is allowed to move 2% above or below that midpoint, which is called the daily fixing. That said, the PBOC does ignore the daily moves at times and sets the fixing so that the CNY is stronger against the greenback when there is an indication that it should be weaker. Based on yesterday’s close, CNY depreciated by 1.9% from the previous day to close at 6.33 per USD.

- China’s export stumbled on strong CNY currency. Export contracted by 8.4% YoY to USD195.1bil in June. The contraction in overseas shipment is partly attributed to the strong CNY, which led to the fall in exports to EU (-12.3%) and the US (-1.3%). China’s exports to EU accounted for 15.9% of total exports while the US contributed a significant 18.0%.

- External challenges for the US. This could pose a challenge for the US on the back of the strong USD, as the Fed prepares to raise interest rates later this year. A concern for the Fed has been the relatively stronger USD, which is hampering exports and keeping inflation rate below the Fed’s 2% target. Now that the PBOC has devalued the CNY, the USD is likely to continue appreciating and it could be exacerbated further when the Fed actually raises rates.

- Strong appreciation of the CNY since de-pegging in 2005. As a recap, China surprised global financial markets on 21 July 2005 when it removed the currency peg, which had valued the USD at CNY8.28 since 1997. By Monday’s close, the USD bought CNY at 6.2097, which is about a 25% appreciation against the USD since the de-pegging of CNY in 2005.

- Negative for the Ringgit, but a boost for Malaysia’s exports. For Malaysia, the devaluation of CNY is negative for the Ringgit, which has been trading weakly vis-à-vis the major counterparts, including the USD. However, the weak Ringgit is expected to augur well for trade and in support of stronger exports, especially for shipments to the US. As noted in the recent trade statistics, exports growth rebounded to +5.0% totalling RM64.3bil in June vs. -6.7% in May. The rebound in exports was partly driven by the shipments to China (+49.3% YoY) and exports to the US (+9.5%).

- Accumulation in current account surplus and further scope to defend the weak Ringgit? Should Ringgit stay lacklustre, exports growth could improve and net trades are likely to advance. Nonetheless, a sustainable improvement in international reserves is rather unlikely as the boost in current account does not necessarily lead to a pick up in the reserves. Based on a correlation analysis of current account vs. balance of payment, the coefficient correlation is 0.04. On the other hand, current account and USD-denominated reserves are negatively correlated, bearing a coefficient correlation of -0.43.

- Steep deterioration in Ringgit vs. USD. Ringgit closed at 3.9615 per USD yesterday (or -0.8% from the previous day). Compared to CNY, Ringgit strengthened by almost 1.0% to close at 0.62 per CNY. The international reserves had deteriorated to defend the weak Ringgit currency as at YTD July 2015. That said, overall reserves at BNM would probably stay under tremendous pressure despite the inflows through trade, as the Ringgit remains highly volatile against major currencies.

Source: AmeSecurities Research - 12 Aug 2015