How To Think About The RMB And Implications For The World? - Citi
The recent weakening in the RMB and volatility in Chinese financial markets have been associated with major spillovers to financial markets in the rest of the world, notes Citigroup.
"In our view, the weakening in the RMB reflects i) persistently large capital outflows, driven by fundamental challenges to the economy and politics; and ii) at the same time, ongoing reforms in the Chinese monetary policy regime towards greater FX flexibility, which we believe is compounding general policy uncertainty. This regime shift in part reflects a change in assessment of the relative benefits vs. costs to RMB stability, especially when it comes to rapid FX reserve losses, the need to strengthen monetary independence and reflate the economy," Citi argues.
"Factoring in this change, we now expect RMB to depreciate faster than we thought previously and forecast USDCNY at 7.20 in 12M (a further 9% depreciation), which, given a stronger USD vs other currencies, would imply around 5% depreciation of the RMB vs the CFETS RMB basket. The process is unlikely to be smooth/linear and will proceed in fits and starts, as the last few days already suggest, with periodic efforts at intervention and some tightening of capital outflow measures," Citi projects.
"The weakness in, and uncertainty around, the RMB and Chinese growth are disinflationary and weaken demand growth in the rest of the world (ROW). Even though the direct impact of a ‘pure depreciation’ on the ROW is probably modest, spillovers are larger if the RMB weakening is due to significantly weaker Chinese growth. Financial market spillovers and concerns about policy ineffectiveness elsewhere could magnify the global ramifications of China shocks. China-driven volatility in financial markets is likely to be as present in 2016 as in 2015 or more so.
The Chinese developments are also part of a bigger picture in that more countries and central banks are willing to use exchange rate weakness (and, to a lesser extent, exchange rate flexibility more generally) as a shock absorber or a tool to achieve other policy objectives.
Qualitatively, these developments increase the likelihood of further easing and reduce the likelihood of tightening for advanced economy central banks. However, the latest Chinese developments have not led us to change any of our major monetary policy forecasts for now," Citi adds.
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