Economics Markets Strategy - the DBS Vickers Securities Equities ...

Economics – Markets – Strategy
Currencies
Chinese yuan – appreciation pace to slow with diminished overheating risks
We are reining back our expectations for CNY appreciation. The factors responsible
for faster pace of appreciation since Jul 2005 have weakened in 2008. For 2008,
we now expect CNY to rise by a smaller 8.1% appreciation against USD, compared
to 12% previously. We have also slowed the appreciation for 2009 to 4.7% from
5.5% previously. This should translate into a USD/CNY rate of 6.75 and 6.45 by
the end of 2008 and 2009 respectively.
Since its de-peg in Jul 2005, the CNY has been increasing its appreciation pace.
Initial pressures came from the US-led G7 nations, triggered mainly by China’s
ballooning trade surpluses and the widening bilateral US-China trade deficit. As
time progressed, the pressures for faster CNY appreciation started to come more
from domestic sources, namely as a need to pre-empt overheating pressures. By
2007, China’s economy posted its fifth straight year of double-digit growth with
inflation becoming a serious concern after it rose above 5% from Jul07. The
Chinese stock market was the toast of equity investors, as the the Shanghai
Composite Index increased almost six-fold between Jul 2005 and Oct 2007. Thanks
to robust trade and capital inflows, foreign reserves surged to USD1.76 trillion
in Apr08, a whopping trillion richer than the USD733bn posted in Jul05.
Hence, it did not come as a surprise that the NDF (non-deliverable forward)
market was pricing for faster and faster CNY appreciation throughout 2007 into
1Q08. At its peak on Mar 13, the NDF market was projecting an appreciation of
13% over the next 12 months. Since then, that expectation has whittled to
4.9% by Jun 11.
So, what has changed? For a start, investors are finding it difficult to ignore the
struggling stock market, where the Shanghai Composite Index has fallen more
than 70% from its peak. Like it or not, the stock market decline coincided with
the slowdown in the economy. GDP growth decelerated for the second straight
quarter to 10.6% in 1Q08, below 11% for the first time since 4Q05. Another
surprise was the trade surplus, which narrowed in the first four months from a
year ago levels. The same narrowing was also seen in the bilateral US-China
trade deficit. Understandably, the central bank is becoming comfortable that
overheating risks have diminished.
USD/CNY
forecast, eop
Latest Prev
Close 6.92 7.10
2Q08 6.90 6.90
3Q08 6.80 6.70
4Q08 6.75 6.50
1Q09 6.70 6.30
2Q09 6.65 6.26
3Q09 6.55 6.21
4Q09 6.45 6.16
PBOC 1Y lending
forecast, eop
Latest Prev
Close 7.47 7.47
2Q08 7.47 7.74
3Q08 7.47 8.01
4Q08 7.74 8.01
1Q09 8.01 8.01
2Q09 8.28 8.01
3Q09 8.28 8.01
4Q09 8.28 8.01
Latest close on Jun 11
Prev close on Mar 12
Even so, these factors are not sufficient to abandon the CNY’s appreciation bias.
China is still reporting double-digit growth, foreign reserves are still rising strongly
and trade surpluses are still wide. But they are no longer flagging large overheating
risks. With US and G7 no longer pushing hard for a weak USD because of the oil
crisis, there’s a case to scale back appreciation expectations for the CNY.
Market sees CNY slowing appreciation pace
China stocks anticipated GDP slowdown
24
22
20
18
16
14
12
10
8
6
4
2
USD/CNY
1Y NDF (rhs)
% appreciation
implied by 1Y NDF
Jan-05 Jan-06 Jan-07 Jan-08
USD/CNY
Spot (rhs)
8.50
8.00
7.50
7.00
6.50
6.00
5.50
5.00
4.50
4.00
3.50
12.5
12.0
11.5
11.0
10.5
10.0
GDP growth
(% YoY, lhs)
Shanghai Comp
Index (rhs)
Jan-05 Jan-06 Jan-07 Jan-08
7000
6000
5000
4000
3000
2000
1000
0
31