CNY: Renewed depreciation after SDR inclusion – RBC CM

Research Team at RBC Capital Markets, believes that China engineered a narrower CNH/CNY basis and stability in USD/CNY and USD/CNH below 6.70 ahead of 1 October and RMB’s formal inclusion in the IMF’s SDR basket.

Key Quotes

“Now that we are past this hurdle, we expect renewed appreciation in USD/CNY. Initial signs are this is happening, with CNH breaking through 6.70 in early October. We maintain our end 2016 USD/CNY target of 6.95. Evidence shows RMB internationalisation has slowed in the past year and the headwinds to RMB becoming a truly international currency, despite SDR status, will persist for at least the next two years.

There has been some focus on the recovery in activity data. However, this has been on account of a surge in state spending. Infrastructure investment has been the Chinese government’s preferred countercyclical tool to support economic growth eg. municipal, utilities and transport infrastructure. For a long time, this has made sense given China’s ongoing urbanisation process. However, the government has leaned increasingly on infrastructure spending to plug the gap of slowing private investment.

Since the end of 2015, private fixed asset investment growth has slowed from 10%y/y to 2.1%y/y in August, a record low. Meanwhile, fixed asset investment by the State has more than doubled from 9.9%y/y to 23.5%y/y, a near 6.5 year high (August: 21.4%y/y). This is an unsustainable situation.

6-12 Month Outlook – Few options left

Of particular concern is the continued trend deterioration in key labour market indicators and other indicators pointing toward stalling in the economic rebalancing toward the services sector. There is a limit to how much China can rely on State support. Despite calls for widening the fiscal deficit toward 5%, an augmented fiscal deficit measure that includes (estimated) local government and off-budget activity is already ~8% of GDP. This means the potential for meaningful fiscal stimulus in China is much lower than appreciated, particularly if the liquidity driven resurgence in the property sector fades, weighing on revenues from land sales. We remain comfortable targeting USD/CNY at 7.5 in 2017.”