Chinese Yuan (CNY) past the key 7.00/US$ level first time since March 2008

The People’s Bank of China (PBOC) allows the Chinese yuan (CNY) to weaken further since early August, where it has depreciated by 4.1% to 7.15/US$, past the key 7.00/US$ level for the first time since March 2008. This was despite an earlier statement in early August by PBOC that the central bank will not use its yuan currency as a tool to counter the trade disputes with US due to tariff imposed. In early August, PBOC’s Governor Yi Gang also added that China will not engage in competitive devaluation of the yuan.

However, with recent unexpected depreciation of the CNY/US$ continuing, there are rising concerns that PBOC may likely accelerate further to devalue its CNY in order to cushion against US tariffs. In 1H19, China’s export growth declined by an average of 0.5% yoy compared to an expansion of 13.6% in the same period last year. Furthermore, we believe PBOC is also concerned about the country’s economic slowdown, where its GDP growth in 2Q19 eased to a 27-year low of 6.2% yoy (6.4% in 1Q19).

According to Kevin Lai, chief economist from our alliance partner Daiwa Capital Markets, with the recent slide in the CNY, he feared that borrowers would likely be under greater pressure to manage their dollar debt and FX exposure. He cautioned that lenders (banks and bond investors) may be turning more cautious in providing dollars. Kevin also believes China, which has depended heavily on dollar debt inflows to support its CNY, may see borrowers start unwinding and lenders tighten up, putting pressure the ability to generate fresh inflows will dwindle rapidly. Based on his assessment, the 7.00 mark is by no means merely psychological, and has revised his forecast for CNY to weaken to 7.60/US$ by end-2019 and remain at the same level by end-2020 (from a projection of 7.00/US$ previously).

While not discounting the risk for further CNY depreciation, we believe that with China’s economic fundamentals remaining healthy, as well as previous experience of PBOC in handling and maintaining its stable operations of the foreign exchange market, in our view, the likely outcome will likely be one where the CNY moves in an orderly manner based on market supply and demand in the months ahead (despite the recent weakness), avoiding disorderly movement of capital flow in the short term. Based on historical trends, in 2015, PBOC had also devalued the CNY three times beginning from 11 August 2015, which led to depreciation of 4.4% against the US$ in that year. CNY was hovering between 6.20-6.40/US$ (from around 6.1-6.2 in 2013 and 2014). PBOC had guided during that time that the devaluation was part of its reforms to move towards a more market-oriented economy. However, the net foreign outflows from China totalled US$75.2bn during that period. Meanwhile, the Shanghai Stock Exchange had also fallen sharply between August 2015 and February 2016, by 16.2%.

Source: Affin Hwang Research - 30 Aug 2019