Is China a "currency manipulator"? Yes! CME-meeting, 2/5/11, Chief Economist Øystein Dørum, DnB NOR Markets 1 2. mai 211
Overview: Fifteen years four stages USD-peg at 8,28 from Asian crisis 1997, until 21/7/25. From peg to (yet unknown) basket and 2% revaluation vs USD, followed by gradual appreciation both vs USD and trade-weighted. Faster as the economy picked up speed. Mid-July 28-July 21: Stable USDCNY around 6,83 due to financial crisis and lower exports. CNY followed the USD down. July 21: Signalling freer float after increasing pressure in China and accusation of currency manipulation. 4.8% appreciation vs USD thus far. But nothing trade-weighted. Will continue. Necessary for domestic stabilisation. 6.5 7. 7.5 8. 8.5 CNY 12 1 11 1 95 9 85 Apr-1 Apr-6 Apr-11 USDCNY (inv) TWI (rha) Sour ce: T homson Datastr eam/ DnBNOR Mar kets 2 2. mai 211
Not just another bad hair day Jan-5: Will introduce gradually appreciating crawling peg by midyear. Began predicting USDCNY May-6 Average deviation 12m ahead (13 obs.) 2.%. No directional errors: Our best currency forecasts. (Only truly bad forecasts are the ones made Aug 28-Apr 29, with a belated acknowledging that economic conditions put further appreciation on hold.) In a sense paradoxical, as we should have better grasp of currencies closer to home. Obvious, two-fold explanation: This is a managed ("dirty") float, and developments reflect underlying economic conditions. 6. 6.5 7. 7.5 8. 8.5 USDCNY Jan-5 Jan-7 Jan-9 Jan-11 Jan-13 Actual DnB NOR Markets Sour ce: T homson Datastr eam/ DnBNOR Mar kets 3 2. mai 211
Is China a currency manipulator? Yes Managed, not market-determined exchange rate. Many years with a trade surplus indicates an undervalued currency. Large capital inflow in addition (reserves increasing faster than the surplus) supports this view. China's currency reserves stood at $345''' by 31.3.211, 52% of GDP & 17 times reserves in 21Q1 (=33%/year). This is classic mercantilism. As a poor, fast-growing nation China should have imported capital. 12 China: Net exports & reserves Change m/m in USD bn 35 3 Currency reserves, USD bn 9 25 6 2 3 1-3 5-6 Mar-1 Mar-6 Mar-11 FX Reserves Trade balance Sour ce: T homson Datastr eam/ DnB NOR Mar kets Q1 21 Q1 26 Q1 211 G7xJap Japan China Trs Sour ce: T homson Datastr eam/ DnB NOR Mar kets 4 2. mai 211
China was hit by The Great recession In the Winter 28/9 the value of exports fell at an underlying rate of over 5%. From 28Q3 to 29Q3 exports fell by 25%. HSBCs PMI index was below 5 (contraction) from August 28 to March 29. Production growth declined from -2% y/y to 5% y/y. 1 5-5 -1 - -2-25 G7 man.prod./china's exports Percentage change y/y Mar-1 Mar-6 Mar-11 5 4 3 2 1-1 -2-3 6 55 5 45 4 PMI og manuf. production Mar-5 Mar-7 Mar-9 Mar-11 21 17 13 9 5 G7 IP Sour ce: T homson Datastr eam/ DnBNOR Mar kets China's exports (rha) HSBC-PMI, sa Sour ce: T homson Datastr eam/ DnBNOR M ar kets Production, y/y (rha) 5 2. mai 211
Policy changed 18' (and back again) Tighter policy from 25 to 27, but full turnaround in 28, with lower reserve ratio and interest rates, and strong lending growth: CNY7,5''' in new loans 29H1, three times 28H1. Credit rose 33% in 29. Policy tightened again in 21. RRR raised 5 pp since last January, of which 3½ pp since mid-november. 22 2 18 16 14 12 1 8 6 Signal rates and reserve req. Per cent 8. 7.5 7. 6.5 6. 5.5 5. Apr-1 Apr-6 Apr-11 RRR sm all banks RRR large banks 1y loan (rha) Sour ce: T homson Datastr eam/ DnB NOR M ar kets 16 14 12 1 8 6 4 2 China: Credit Mar-1 Mar-6 Mar-11 Net new loans, CNY bn m/m (3mmav) Credit to private sector (y/y, %, rha) Sour ce: T homson Datastr eam/ DnB NOR Mar kets 4 35 3 25 2 1 5 6 2. mai 211
The exchange rate is part of the game A weak transmission mechanism due to large liquidity surplus in the banks reduce the effect of interest rates for stabilisation purposes. A stronger yuan weakens competitiveness, dampens imported inflation and should also counter "speculative" inflow and therefore domestic liquidity and credit growth. 2 USDCNY and required reserve ratio 19 17 2 USDCNY and lending rate 8. 7.5 7. 1 5 13 11 9 1 5 6.5 6. 5.5 5. -5 7 Apr-5 Apr-7 Apr-9 Apr-11 USDCNY 3m /3m ann. RRR (rha) Sour ce: T homson Datastr eam/ DnB NOR Mar kets -5 4.5 Apr-5 Apr-7 Apr-9 Apr-11 USDCNY 3m /3m å.r. 6-12m (rha) Sour ce: T homson Datastr eam/ DnB NOR M ar kets 7 2. mai 211
Also in containing inflation Inflation currently 5.4% - the most important reason behind the ongoing tightening of monetary and credit policy. Inflation likely to moderate going forward, not warranting similar appreciation as seen in 27. Also, global growth apparently less robust. China still enjoys healthy growth, with GDP up 9.7% in 211Q1, and April PMI at 52. 1 China: CPI and USDCNY, % 2 China: GDP and PMI 6 8 16 12 55 6 12 9 5 4 2 8 4 6 45 3 4-2 -4 Apr-1 Apr-6 Apr-11 CPI y/y USDCNY 3m/3m, ann. (rha) Sour ce: T homson Datastr eam/ DnBNOR Mar kets 35 Q1 25 Q1 27 Q1 29 Q1 211 GDP y/y HSBC/Markit PMI (rha) Sour ce: T homson Datastr eam/ DnB NOR M ar kets 8 2. mai 211
A big, unsustainable paradox According to US Treasury data (TICS), China increased its net purchases of US treasuries during the financial crisis. Currently holds $14''', equal to 39% of its reserves. ('Nominee' accounts in addition, but holdings could in principle also include private holdings.) The paradox? Poor and fast-growing China finances rich and slower-growing USA. The biggest debtor and the biggest creditor, tied together. China can not stop buying, as a large USD decline would also affect competitiveness. 4 3 2 1-1 -2-3 Current account Per cent of global GDP 1996 2 24 28 212 216 OIL CHN+EMA DEU+JPN USA OCDC RoW+ Sour ce: IM F WEO111/ DnB NOR Mar kets China: Holdings of US trs 12 5 1 4 8 3 6 4 2 2 1 Mar-1 Mar-6 Mar-11 bn USD % of all reserves (rha) Sour ce: T homson Datastr eam/ DnBNOR Mar kets 9 2. mai 211
A huge economy with a small currency China has now acquired the position as the world's second largest economy and importer, and the largest exporter and capital exporter. But its currency has marginal significance. According to BIS' latest Triennial Central Bank Survey (daily turnover, April 21), the CNY was involved in.9% of all fx transactions, less than the NOK's 1.3%. This will change. History shows that economic strength and currency significance goes hand in hand, although with considerable lags. Although US relative importance is declining, the USD is still the world's currency. Exports in USD Per cent share of global exports 1 Daily global fx turnover Per cent of total (sum 2%) 12 8 9 6 6 4 3 2 1995 2 25 21 China USA Japan Sour ce: T homson Datastr eam / DnB NOR M ar kets 1998 21 24 27 21 Sour ce: BIS / DnBNOR M ar kets USD EUR JPY GBP NOK CNY 1 2. mai 211
China at crossroads Five year plan 211- (announced 29/1/1) with overriding aim of stable and "relatively fast" growth, but also to "accellerate" rebalancing. Growth should lean more on consumption and services, and less on investments, exports and manufacturing. Energy intensity and emissions to be reduced. (1% GDP-growth and 6% emissions growth since 198.) How? Better welfare. Higher SOE dividends. Technology. Export industry and stable exchange rate will be less important. China: GDP shares, % 5 45 4 35 3 25 2 199 1995 2 25 21 Manuf. prod. GFCF Services Private cons. Sour ce: EIU/ T homson Datastr eam/ DnB NOR M ar kets China: GDP and CO2 emissions 4 7 35 6 3 5 25 4 2 3 1 2 5 1 198 199 2 21 GDP. Bn 25-USD Mill.ton CO2 (rha) Sour ce: EIA/ T homson Datastr eam/ DnBNOR M ar kets 11 2. mai 211
Gradual liberalisation Last year importers and exporters were allowed to price imports and (gradually) exports in CNY. Strong increase during the course of the year, but payments for imports dominate. Probably largest potential in trade with EMEs, which are increasing their share of Chinese exports. Large outflows reflected in build-up of offshore HK market, creating a "shadow" CNY market (CNH), due to restrictions on mainland inflows. Big companies, e.g. McDonald's & Caterpillar, have borrowed in CNH. As a surplus country, trade should not cause large CNY reserves abroad. 5 4 3 2 1 China: Foreign trade w/ EMEs Pct share of total, 6m mav 199 1995 2 25 21 Imports Exports 12 1 8 6 4 2 Trade priced in CNY Billion CNY Aug-9 Jan-1 Jun-1 Nov-1 Sour ce: T homson Datastr eam / DnB NOR M ar kets Sour ce: Peopl e*s Bank / DnB NOR M ar kets 12 2. mai 211
but still a long way to go Hu Jintao: "[The] international currency system is the product of the past" But: "[ making the yuan] an international currency will be a fairly long process" DnB NOR Markets: Currently expecting 2-3% appreciation vs USD over the next 12 months (but also a 1% USD trade-weighted appreciation). No major liberalisation over the courseofthenextthreeyears. But there's no doubt about the direction: Stronger, more flexible. 13 2. mai 211
Memo Markets expect further appreciation Non-deliverable forwards (NDF's) are currently indicating an appreciation of 3%, 7% and 9%, one, three and five years ahead, respectively. Like economists, markets expectations are adaptive, cf. relationship between actual, annualised change and expected forward change. (But late 28 markets were pricing in a depreciation of CNY vs. the USD.) 14 12 1 8 6 4 2-2 China: USDCNY, spot and NDFs Expected appreciation in per cent Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 3m 1y 3y 5y Sour ce: T homson Datastr eam / DnB NOR Mar kets 25 2 1 5-5 -1 USDCNY, % change Apr-5 Apr-7 Apr-9 Apr-11 3m/3m, ann. NDF: 1y forw ard Sour ce: T homson Datastr eam/ DnBNOR Mar kets 14 2. mai 211
Disclaimer Denne rapporten må anses som markedsføringsmateriale med mindre den er utarbeidet i henhold til krav for investeringsanalyse, jf Forskrift til verdipapirhandelloven 27/6/29 nr 876. Denne rapport er utarbeidet av DnB NOR Markets som er en divisjon i DnB NOR Bank ASA. Rapporten baserer seg på kilder som vurderes som pålitelige, men DnB NOR Markets garanterer ikke at informasjonen er presis eller fullstendig. Uttalelsene i rapporten reflekterer DnB NOR Markets oppfatning på det tidspunkt rapporten ble utarbeidet, og DnB NOR Markets forbeholder seg retten til å endre oppfatning uten varsel. Rapporten skal ikke oppfattes som et tilbud eller anbefaling om kjøp eller salg av finansielle instrumenter eller deltagelse i noen investeringsstrategi. DnB NOR Markets påtar seg intet ansvar for verken direkte eller indirekte tap eller utgifter som skyldes forståelsen av og/eller bruken av denne rapport. Regler om konfidensialitet og andre interne regler begrenser utvekslingen av informasjon mellom ulike enheter i DnB NOR Markets/DnB NOR konsernet, hvilket innebærer at ansatte i DnB NOR Markets som har utarbeidet rapporten er forhindret fra å bruke og være kjent med tilgjengelig informasjon i DnB NOR Markets, og andre selskaper i DnB NOR konsernet, og som kan være relevant for mottakerens avgjørelser. Informasjon om DnB NOR Markets Alminnelige forretningsvilkår er tilgjengelig på vår hjemmeside www.dnbnor.no/markets. Denne rapport er kun ment å være til bruk for våre klienter, ikke for offentlig publikasjon. DnB NOR Markets, en divisjon i DnB NOR Bank ASA - organisasjonsnummer 984 851 6 i Foretaksregisteret, er medlem av Norges Fondsmeglerforbund og underlagt tilsyn av Finanstilsynet i Norge, Singapore, og i begrenset utstrekning i Storbritannia. Ytterligere informasjon om DnB NOR Markets og DnB NOR Bank ASA finnes på www.dnbnor.no. 2. mai 211