Throughout 2017, the international foreign exchange market will be reacting to a wide range of political and economic developments. The world will be watching to see whether the new US government will live up to its protectionist rhetoric and its potential impact on the US dollar. And in China, Beijing’s attempts to stem capital outflows will be a key theme for the renminbi.
Both these topics were addressed in detail by Joey Chew, Asia FX Strategist, Global Research, HSBC Hong Kong. Speaking at HSBC’s Asian Outlook & RMB Forum, held in Kuala Lumpur, Ms. Chew discussed broad dollar trends, the renminbi’s progress towards becoming an international currency, as well as the prospects for Malaysia’s ringgit in 2017.
Starting with the world’s largest economy, Ms. Chew highlighted that US dollar’s post-election rally had run out of steam, with the greenback losing around half of its 5% gain in the first two months of the year.
Events in Washington have weighed on the US dollar, as the news flow focused on policies related to reducing immigration and potential trade restrictions. But there is also an economic reason behind the more recent softening in the US dollar, said Ms. Chew. In short, data coming out of the US economy has stopped surprising on upside, while emerging markets have started to beat expectations.
“The US recovery story has broadened out into a global story this year, which is why other currencies have appreciated against the dollar,” said Ms. Chew. She also pointed out that the US dollar is overvalued against a large number of currencies.
It is however still too early to call time on the strength of the US dollar. HSBC expects the currency to undergo another phase of appreciation later in the year, when Washington starts to discuss policies that could stimulate the economy – such as infrastructure spending and tax reform that could encourage multinationals to repatriate profits back to the US.
The strength of the US dollar is especially important for China, where the authorities have been doing their best to prevent the renminbi from depreciating too quickly against the greenback. One of the most effective policies used so far is raising interest rates in the market for offshore renminbi (also known as the CNH market).
This forces speculators holding short positions on the CNH to close their positions, which they do by buying renminbi in the spot market. When they do this, said Ms. Chew, it causes the US dollar to fall against the CNH, which in turn affects sentiment on the mainland, thus dragging the US dollar down against the onshore renminbi (CNY).
The problem with this strategy is that it requires the People’s Bank of China to sell its FX reserves, which recently fell below Rmb3 trillion. The International Monetary Fund calculates that the level of reserves needs to be about Rmb2.2 trillion, which still leaves some room for further policy manoeuvre. But at the same time, shrinking reserves could have a negative impact on confidence.
China’s efforts to shore up the renminbi against the dollar are hindered by ongoing capital outflows, as businesses and individuals send money out of the country. The government has tightened the procedure for buying foreign currencies with demands for additional disclosures to make sure that the money will be used for legitimate purposes.
“Despite this enhanced regulatory control, HSBC’s view is that capital outflows this year are still going to exceed inflows,” said Ms. Chew. “Therefore the bias for the renminbi is to still depreciate this year”.
The reason lies in China’s services trade balance, which is mostly caused by Chinese people travelling abroad – in effect, a tourism trade deficit. Ms. Chew said that even if the tighter checks on foreign exchange purchases were able to catch all the speculative trading, there will still be a $250 billion deficit coming from trade in services. On corporate flows, companies are going to continue investing abroad, which will also contribute to continued outflows in 2017.
Capital outflows, along with renewed strength in the US dollar to come, means that the renminbi is likely to suffer another year of modest depreciation. But with the currency entering its third year of decline, it is a good time to assess the impact that more falls will have on its progress towards becoming an international currency.
Ms. Chew said that the ongoing depreciation of the renminbi has caused challenges for internationalisation. She cited the fact that CNH deposits have already fallen a third from their peak, while trade settlement denominated in the Chinese currency is currently back at 2014 levels, and the market for RMB-denominated bonds issued offshore (known as dim sum bonds) has also shrunk. But despite the setbacks in the offshore market, progress is still being made in the onshore market.
“Internationalisation is happening in various routes, and it is not just happening in the offshore market,” said Ms. Chew. In particular, China has opened up its bond and equity markets to international investors. Foreign ownership in Chinese onshore securities remains extremely low compared to other markets, and there is plenty of room to grow.
“We will eventually get to a point where foreign investment in Chinese securities will be able to match the outflows coming out from Chinese residents,” said Ms. Chew. When there is a balance in cross-border flows, she said, the renminbi will start to appreciate again and the currency’s internationalisation story will resume in earnest.
Ms. Chew finished her outlook with a discussion of Malaysia’s ringgit, which unlike most of emerging market currencies, has been weak since the US election. Part of the reason is that foreign investors have been divesting their holdings in Malaysian bonds, resulting in capital flowing out of the country.
The central bank, Bank Negara Malaysia, has already put in place measures that may pave the way for the ringgit to eventually recover. There is also special emphasis on rebuilding the bank’s foreign currency reserves, as the central bank’s stockpile of assets have fallen to the lower half of the adequacy range defined by the IMF.
Beyond policy support, a recovery in global trade and commodity prices will also support the ringgit. The export of electronics goods has surged in some Asian countries, and Ms. Chew said that it was only a matter of time before something similar happens in Malaysia, a development that will help the general trade balance to improve.
“When the external conditions are right, the ringgit will resume its recovery,” said Ms. Chew. “It may not happen this year, but it may well be the case next year.”