Market Outlook - BNP PARIBAS - Investment Services India

CNY: Revaluation and FX Reserves
• Chinese inflation and initial tightening
measures are raising market expectations for a
resumption of CNY appreciation.
• Beijing’s decision on the timing and extent
of appreciation will probably hinge not only on
domestic inflationary pressures but also on the
extent to which global growth rebounds;
whether or not a quid pro quo can be negotiated
with the West will also play a part.
• The introduction of a crawling peg in 2005
triggered hot money inflows as China was
continuing to invest in export capacity,
promising further surpluses. Today, China has
moved its focus to domestic demand
development, suggesting internal and external
surpluses will decline.
• We lay out the road map towards Sterling
devaluation.
Chinese revaluation is inevitable…
Recent moves by the PBOC – tightening reserve
requirement ratios and hiking bill yields – have
highlighted the inflation and bubble risks associated
with the Chinese growth story. The perception that
these measures may not be sufficient to tame
excesses has many viewing a further appreciation of
the Chinese Yuan as inevitable.
The repercussions of such a revaluation are seen as
widespread. Some see a resulting restoration of
balance in global trade systems while others see the
end of Chinese FX intervention as the death-knell for
US Treasuries, the EUR and the AUD. But we beg to
differ here: we see no major change from the status
quo as China moves towards a stronger currency.
…but financial system still awash with liquidity
How far the Chinese tightening proceeds against a
still-uncertain global growth environment is anyone’s
guess. But it appears that the rate of liquidity
absorption in the system could be lagging,
underpinning the recent moves by Beijing to adjust
3M and 1Y PBOC bills higher in yield and increase
bank reserve requirements for larger deposit-taking
institutions by 50bp to 16%.
Indeed, beyond the relatively self-evident facts
embedded in Chart 1, showing the continuing spike
in money supply, FX reserves and outstanding
PBOC bills, is the less manifest reality that
sterilisation bill issuance in China in net terms has
USD bn
2500
2000
1500
1000
500
0
Mar-04
Chart 1: PBoC’s FX Sterilization (I)
Sep-04
Mar-05
Sep-05
Source: CEIC, BNP Paribas
USD bn
300
250
200
150
100
50
0
-50
-100
FX Reserves
Outstanding PBoC Bills
M0 Money Supply %YoY (RHS)
Mar-06
Sep-06
run behind the overall build in FX reserves, at least
by our (admittedly lagging) calculations (Chart 2).
Market crying wolf over liquidity withdrawal
Despite fears of withdrawal of liquidity, the reality is
that loan growth has continued to soar, with local
Mar-07
Sep-07
Mar-08
Sep-08
Chart 2: PBoC’s FX Sterilization (II)
1Q.04
Bill Issuance (USD bn)
Net Issuance (USD bn)
Change in Foreign Reserves (USD bn)
M0 Money Supply %YoY (RHS)
3Q
1Q.05
3Q
1Q.06
Source: CEIC, PBoC, BNP Paribas
thousand billions
3Q
1Q.07
3Q
1Q.08
3Q
1Q.09
Chart 3: 2007-09 Deposits vs Loans
Source: Reuters EcoWin Pro
Mar-09
3Q
%YoY
18
Sep-09
20
18
16
14
12
10
8
6
4
2
0
16
14
12
10
8
6
4
2
0
%YoY
Rob Ryan 29 January 2010
Market Mover, Non-Objective Research Section
47
www.GlobalMarkets.bnpparibas.com