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CNF Focus | Strong appreciation of RMB

Strong appreciation of RMB

On December 9, the SGX US/CNH futures hit a two-year low of 6.4988, a drop of 9.8% in about six months. It would cost roughly 70,000 RMB less than half a year ago to exchange for $100,000 !

Exhibit 1. SGX USD/CNH (UC) futures trend

In the first half of 2020, there was strong anticipation of RMB depreciation due to the impact of the COVID-19 and the financial crisis. The offshore USD/CNH rate hit a ten-year low of 7.2059 on May 28. Yet in the following six months, the USD/CNH rate rose in a strong trend without even a decent retracement. What has caused the appreciation of the RMB? Will this trend persist?

Trade Factor

The expanding trade surplus is the number one reason for the appreciation of the RMB.

Since the beginning of the year, the COVID-19 has been spreading overseas. More than half a million new confirmed cases per day have slowed or even halted production in many countries. Because in the event of a confirmed case, the entire plant could be quarantined and unable to work. In response to the epidemic, developed countries introduced massive stimulus policies, such as a $1,200 subsidy for each resident in the United States. While production in developed countries was affected by the epidemic, consumer demand was not weak. Under the mismatch between supply and demand, a large number of orders were shifted to other countries.

While production has decreased in developed countries, many countries from emerging market are also plagued by the epidemic. As of November 24, 13 of the top 20 countries in terms of cumulative number of confirmed cases of the COVID-19 are developing countries. Three of the BRIC countries except China, namely India, Brazil and Russia, are in the top five in terms of cumulative number of confirmed cases [1].

Taking masks as an example, a situation of "Chinese production + Overseas consumption" has been formed. In 2019, the production capacity of China's masks was 20 million per day, and on April 24, the daily scale of China's exported masks exceeded 1.06 billion. According to data from the National Bureau of Statistics, textile exports including masks exceeded 900 billion RMB in the first 10 months of this year, with a year-on-year growth rate of more than 30%[1].

Exhibit 2. Share of Global Merchandise trade exports

While the world is suffering from the epidemic, China expands its production and its year-on-year export growth rate increases. China's dollar-denominated exports grew at a year-on-year rate of 21.1% in November, well above market expectations of 9.5% and up 9.7% from October. Against the backdrop of the RMB's appreciation against the dollar, exports grew at a 14.9% rate in RMB terms. The trade surplus also increased to a record high of $75.4 billion in November, up from $58.4 billion in October [2].

According to the World Bank, China's share of global merchandise trade exports, increased by 2.7% from 14.7% at the end of 2019 to a record high of 17.4% in September. The replacement share came mainly from G7 developed countries, especially the United States [2].

Financial Factor

China's prudent fiscal and monetary policies are another reason for the RMB appreciation.

Facing the risk of recession brought by the COVID-19, central banks have turned on their money printing machines. The Federal Reserve lowered its benchmark interest rate to 0% in March this year and began buying spree of assets, with a monthly asset purchase rate of $120 billion until today. The Fed's balance sheet has increased from $4.2 trillion in March to $7.2 trillion today, an expansion of more than 70% in less than a year [3].

The size of the fiscal stimulus in the US is also extremely large. In fiscal year 2020, the US fiscal deficit reached $3.1 trillion, rising to 15.2% of GDP from 4.6% the previous year, which is a record high since World War II. The total US government debt now stands at $21 trillion, equivalent to 102% of US GDP, and just one step away from surpassing its peak during World War II [4].

To deal with the epidemic, China raised its deficit rate from 2.8% last year to more than 3.6%. However, the size of the fiscal stimulus pales in comparison with that of the United States. Meanwhile, the former Chinese Finance Minister Lou Jiwei publicly suggested at the Caixin Summit in November that the study of an orderly exit from fiscal and monetary policy should now begin [5]. This implies that the tightening of both fiscal and monetary policies in China is on the agenda.

Exhibit 3. US-China Spread return to record highs

Since the Federal Reserve has no plans to raise rates until 2023, the US 10-year Treasury rate has remained at a historic low of less than 1%. With expectations that easing policy will exit in 2021, China's 10-year Government bond rate has returned to where it was before the outbreak of COVID-19. The current US-China spread is as high as 2.5%, the highest range in nearly a decade, which has attracted large inflows of funds into RMB assets.

Exhibit 4. Value of onshore RMB bonds held by overseas entities

In the government bond market, foreign institutions have been increasing their holdings of Chinese government bonds. According to the data from central bank’s Shanghai headquarters, as of the end of November this year, foreign institutions held a total of about RMB 3.1 trillion in bonds in the interbank market. In 2020, foreign institutions' holdings of Chinese bonds have increased significantly by more than RMB 700 billion [6].

Will the appreciation of the RMB continue?

Short-term: China policy adjustment

China is a big exporter, and the continued strong RMB will hurt exports. At the end of the year, export companies reached the sensitive time for foreign exchange. The USD/CNH rate that these companies can accept is basically around 7 , but now the rate has reached 6.6 or even 6.5, which is an unfavorable situation for foreign trade companies.

Chinese regulators may not want to see this situation and even deliberately intervene in the rapid appreciation of the RMB [7].

On October 10, the Central Bank announced that the foreign exchange risk reserve ratio for forward foreign exchange sales was reduced from 20% to 0%. This adjustment actually encourages the investors to hold US dollars, thereby cooling the RMB which has appreciated too quickly.

On October 27, the China Foreign Exchange Trade Center announced that it has taken the initiative to fade out the use of "counter-cyclical factor" in the quotation model of the central parity rate of the RMB against the US dollar. The "counter-cyclical factor" was officially announced by the central bank in May 2017, when the policy was introduced with a purpose of stabilizing the RMB exchange rate. The current fading out has been interpreted as that the regulators want to dispel the market’s expectations for the rapid appreciation of the RMB.

Mid-term: The situation of the COVID-19 in the world

As the COVID-19 vaccine is approved in more and more countries, it’s highly probable that the epidemic will gradually come to an end. Production in developed countries affected by the epidemic will also gradually recover.

Exhibit 5. Comparison of Chinas export share and global industrial production growth rate

With the gradual recovery of supply capacity in other countries around the world, China's advantage of an early production recovery will be weakened, and the share of exports in the world has been converging after a significant increase in the previous period. Recent data show that although overseas epidemics are on the rise, the growth rate of China's epidemic prevention materials exports has dropped significantly. As the global supply capacity gradually recovers and the trade surplus declines, the supporting of exports to the RMB will be reduced.

Long-term: The impact of China-US competition

The further widening of the US fiscal deficit has normalized the practice of "printing money to support the issuance of Treasuries”. A new scenario may emerge, which is the continued decline of the US GDP share of the world and the continued rise of the US debt share of the world. The decline of the GDP share makes the “anchor” of US dollar start to become smaller, and the rise of the debt share makes the intrinsic value of the US dollar continue to decline. The two effects may cause the US dollar to drift as the anchor for other currencies. The search of anchor by global currencies and the emergence of the RMB as a choice means that the RMB has the potential for long-term appreciation.

The IMF's World Economic Outlook predicts that the global growth rate in 2020 is -4.4%, of which the US is -4.3% and Eurozone is -8.3%. China is the only country with positive economic growth this year. In 2021, the global economy will grow by 5.2% and China's forecast growth rate is 8.2%, which is much higher than the 3.1% in the United States and 5.2% in the Eurozone[8]. The fast-growing economy, the easing of trade frictions and the integration of regional agreements may drive the RMB for long-term appreciation.

More noteworthy: RMB volatility

With the announcement by the Foreign Exchange Center that the RMB counter-cyclical factor is fading out of use, there has been a significant widening of the RMB in terms of the spread between both the central parity rate and opening price or the closing price. This indicates that the central bank's tolerance for RMB exchange rate volatility has increased and the market-oriented reform of the RMB exchange rate has gone one step further.

Exhibit 6. Increased Volatility of RMB

Foreign exchange expert Han Huishi writes that as the central bank withdraws from normalized market intervention, there must be substantial exchange rate fluctuations. If the central bank refrains from intervening in the market, we shall be bold and imaginative about the fluctuation range of the RMB [9].

Overall, as China was the first to control the epidemic, the main logic behind the RMB appreciation in the last six months is that production and exports were the first to recover as well as monetary and fiscal policies were the first to return normal. Looking ahead, the adjustment of China's regulatory policies and the fading of the epidemic in various countries will make it difficult for the RMB to appreciate further in a short period of time. But what is more noteworthy is that with less intervention from China's central bank, the volatility of the RMB could reach a new level in the future, making RMB offshore futures more valuable to trade.

References

[1] 李奇霖,新浪专栏《全世界都在印钱,只有中国在生产》

http://finance.sina.com.cn/zl/china/2020-11-25/zl-iiznezxs3594380.shtml

[2] 覃汉,国君固收,《外汇占款未回暖的启示》

https://www.gtja.com/content/research/ficc/zt_201210.m.html

[3] 曹远征,格隆汇《全球货币寻锚,人民币是否进入升值通道?》

https://www.gelonghui.com/p/432220

[4] 高攀、许缘,北京日报《美国2020财年财政赤字创新高》

http://finance.people.com.cn/n1/2020/1018/c1004-31895993.html

[5] 陈益刊,第一财经《楼继伟称明年财政政策扩张力度或小些,赤字率会破3%吗?》

https://www.sohu.com/a/431619398_114986

[6] 单美琪、孟俊莲,华夏时报《外资22个月增持中国债券 连续三个月超千亿》

http://finance.eastmoney.com/a/202010141663241580.html

[7] 巴九灵,吴晓波频道《人民币5个月升值5500点,警惕这波强势上涨》

https://www.gelonghui.com/p/426746

[8] 国际货币基金组织,《世界经济展望》

https://www.imf.org/zh/Publications/WEO/Issues/2020/09/30/world-economic-outlook-october-2020

[9] 一场秋凉,环球外汇网《逆周期因子将淡出中间价模型! 对人民币走势会有何影响?》

https://www.gelonghui.com/p/420659

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2020/12/18
CN First International Futures Limited