As China’s capital outflows stabilizes, UBS AG says it will maintain its current USD/CNY forecast of 6.8 by year end, but sees increasing risk that the CNY may not depreciate by as much against the U.S. dollar and may end the year at 6.6 to 6.7.
Capital outflow and depreciation pressures have let up visibly in the past couple of months. Not only has the RMB stabilized and staged a modest rebound, but China’s official foreign exchange reserves have since reversed back into expansion, rising US$10 billion in March.
UBS says it estimates that underlying non-FDI outflows stabilized at around US$50 billion in March, similar to February’s outflows and on a much smaller scale than in December or January.
Onshore USD/CNY spot daily average trading volumes meanwhile have also come down, as have daily cross-border capital outflows.
On the other hand, China’s trade surplus hit a record US$570 billion thanks to weak imports and low commodity prices last year, taking its current account surplus to US$330 billion (3% of GDP).
Despite this sizeable buffer however, an over 50% jump in outbound investment meant that China’s net non-FDI capital outflows nonetheless more than doubled to US$734 billion in 2015, estimates the bank.
If outflows are attributed to the reduction of corporates’ foreign exchange exposure in a limited scale, they could be seen as "good".
Almost half of China’s net non-FDI outflows last year was due to a drop in foreign liabilities.
The bulk of outflows were also conducted by Chinese corporates and financial institutions adjusting their onshore foreign exchange balance sheets, rather than foreign investors or onshore retail investors, which may be easier for the government to control via banks and state-owned entities.
On the "bad" side of the coin, some outflows are attributed to Chinese corporates and financials increasing their foreign asset holdings.
Given the huge size of their combined balance sheets, such outflows could eventually grow much bigger, as opposed to if it was only a case of foreign investors withdrawing their money from China.
In the near term, a weak U.S. dollar, improved market sentiment and better economic indicators should help support the RMB.
The People’s Bank of China has since February adopted an opportunistic approach in letting the CNY weaken against the basket whilst strengthening slightly against the U.S. dollar so far.
If the U.S. dollar stays weak this year, the RMB may not depreciate by as much. But the RMB would not be allowed to appreciate much more against the U.S. dollar.
Looking further ahead, as the U.S. economy improves and inflation picks up, market sentiment on U.S. Fed intentions and the dollar may change again, keeping open the risk of a renewed surge in RMB and on capital outflow pressures again, says UBS.