AXA IM’s Yao: PBoC shift not permanent

Aidan Yao, senior Emerging Market economist at AXA Investment Managers (AXA IM), discusses the implications of the PBoC’s announcement today to raise the central fixing rate for the CNY/USD and change the RMB daily-fixing mechanism, and concludes that the RMB depreciation is justified by macro fundamentals while changes to the rate-fixing mechanism should increase the RMB’s chance of inclusion in the SDR.

 

  • The People’s Bank of China (PBoC) this morning raised the central fixing rate for the CNY/USD by 1.9%, making it the largest daily adjustment in recent history. Although the move – to weaken the renminbi (RMB) – is justified by the sluggish economy and diverging policies between the PBoC and the Federal Reserve (Fed), we are surprised by the timing and form of the depreciation.
  • Perhaps an even bigger surprise was that the PBoC is changing the RMB daily-fixing mechanism so that it will now take into account market views. On paper this represents a major shift in China’s foreign exchange (FX) regime, making the pricing of RMB more market-oriented. At this time though, we prefer to be cautious on our interpretation of market impact, given the lack of details on the operating side.
  • Overall we do not think today’s move represents a shift in the PBoC’s FX policy that would mark the start of significant RMB depreciation. The pursuit of RMB internationalisation and inclusion in the Special Drawing Rights (SDR), prevention of financial instability (in the form of capital outflows) and the rebalancing of the Chinese economy all require the support of a stable and strong RMB. This is why the PBoC is calling today’s move a one-off adjustment to prevent depreciation expectations from becoming entrenched.

RMB depreciation can be justified by macro fundamentals: We think some currency depreciation is consistent with China’s macro fundamentals, which have manifested recently in the renewed weakness in export growth, sluggish domestic demand and persistent deflation in some parts of the economy. In addition, the PBoC has moved noticeably towards an easing stance while the Fed is approaching the beginning of its tightening cycle. The latter has led to broad-based dollar strength against all major currencies except the yuan. In actual effect, China’s fixed exchange rate regime has tied the RMB to a flying USD, generating significant currency appreciation that is clearly not compatible with China’s macro fundamentals. The market has recognised this incompatibility and kept the CNY and CNH spots at the top-end of the trading band since the start of the year. Today’s move by the PBoC is merely to close the gap between the official and market rates.

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