One-off devaluation of the RMB all but inevitable – Goldman Sachs

Research Team at Goldman Sachs, suggests that there is growing conviction in the market that the rapid pace of capital outflows makes a large, one-off devaluation of the RMB all but inevitable. 

Key Quotes

“At first glance, it is true that the balance of payments for 2015 – fourth quarter data were published last week – paints an alarming picture, with capital outflows up to -$742bn from -$311bn in 2014. This caused foreign exchange reserves to fall -$342bn last year, even with a rising current account surplus thanks to lower oil prices. The thinking goes that this pace of reserve losses is unsustainable and will require a one-off devaluation to get ahead of what some describe as a run on the currency. 

We agree that the current regime for the RMB – one that sees devaluation in fits and starts – is probably unsustainable. That is because periodic attempts to weaken the RMB feed anxiety that a large devaluation is coming, such that capital outflows (and reserve losses) are worse than otherwise.

Meanwhile, the benefits from devaluation are proving elusive, since currencies in the region have sold off hard, inadvertently tightening, rather than loosening, financial conditions. We think Chinese policymakers – like policymakers everywhere – are “learning by doing,” i.e., are exploring how much devaluation is possible. If this is true, they are “learning” that their room for maneuver is extremely limited and that RMB weakness is, in many respects, counterproductive. 

As a result, we think an exit from the current regime of periodic devaluation into a more stable RMB is more likely than a large, one-off devaluation. This should see markets price out a large RMB risk premium, with the SPX reverting to 2000, $/JPY going to 125 and EUR/$ – ahead of the March 10 ECB meeting – going