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How Eight-One-One changed China

China's decision to devalue the renminbi (RMB) in late 2015 has led to a significant change in the way the country views itself economically and the broader outlook for the direction of its currency. Having just returned from China and a series of meetings with investors, corporates, regulators and commentators, I noted a stark shift in attitudes compared with my last visit six months ago.

" The view of China's economic health from within China is now much closer to the view of the rest of the world."
Richard Yetsenga, Acting chief economist at ANZ

Two key themes stood out from the trip: first, there is now widespread expectation of renminbi depreciation and consequently businesses are managing currency risk with more focus. Second, the view of China's economic health from within China is now much closer to the view of China from the rest of the world. This is a huge change.

I was last in China in August 2015, the week after the August 11 devaluation of the RMB, which is now referred to as 'Eight-One-One' in the country, such is the significance of what happened on the date.

At that time, ANZ argued the broad expectation of onshore businesses seemed to be currency stability rather than a weaker RMB over time. “There is no basis for large scale renminbi depreciation," was the People's Bank of China's public assurance.

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As a result, we concluded very few businesses had significantly adjusted their currency exposures in preparation for depreciation. Our sense now is things have shifted radically. There was not one meeting I attended on the trip where RMB depreciation was not the central – and in fact only – expectation.

Much like our recent visit to Europe we spent much of the time arguing while depreciation was also ANZ's central expectation, we do expect the process to be relatively managed and modest rather than asymmetric and disorderly.

As with outside China, there was much discussion of the risk of a one-off devaluation compared with more conventional depreciation over time. The risk of a one-off devaluation was generally assessed as being relatively low, which is consistent with our view.

The following is a collection of the other key themes which arose from the trip.

THE CURRENCY BASKET

There is one particular area we feel the onshore discourse has become unduly narrow: the currency basket. Much like the PBoC's statements last August around depreciation, China's apparent commitment to a currency reference basket will likely head the same way.

The prospective shift in interest-rate differentials over the next few years suggests further RMB depreciation against the US dollar is likely.

If the US dollar also appreciates against other currencies it may well allow the basket arrangement to persist. However, our forecasts for the currencies which comprise the basket suggest this will be difficult.

We expect both the Euro and Yen, the two largest components of China's currency basket, to appreciate against the US dollar over the next couple of years. In this situation, we suspect the RMB might follow the basket for a while but economics is likely to be the ultimate arbiter on where the RMB heads and that suggests medium term depreciation.

CORPORATE-RISK MANAGEMENT

Associated with this shift in the perception around the exchange rate, corporate risk management appears to have shifted relatively quickly to reflect this new reality. Hedging future import demand is now more common while fewer corporates run 'active' currency programs nowadays.

There has also clearly been a material shift towards raising funds in the domestic market, at least partly because of increased acceptance of the risks associated with foreign currency borrowing.

POLICY RESPONSE

Part of ANZ's argument for a controlled depreciation cycle is the policy response has been robust across a broad front.

Examples of this abound. Companies have been facing increased difficulty in buying foreign currency even for legitimate transactions. Overseas credit card transactions now count towards an individual's $US50,000 annual purchase limit and it has become more difficult to borrow RMB externally following the introduction of reserve requirements on offshore deposits.

Much like the policy approach to the domestic leverage issues – extend and delay – the tightening of capital outflows stymies the adjustment rather than allowing it to occur.

OPENING THE BOND MARKET

Surprisingly, the opening of China's bond market to foreign investors is not expected to result in significant capital inflows or at the very least it hasn't been a substantial focus for many market-watchers onshore.

Our sense is the offshore view on this issue would be similar. The possibility of surprise here seems obvious, particularly given our sense this is designed to be a genuine policy shift, rather than simply rhetoric unmatched by practical application.

GLOBAL VIEWS

Global views in China are much like anywhere else: worried. Will the US Federal reserve hike rates this year? In our view yes, certainly. Why did the yen appreciate after the BoJ's latest easing? Because the yen's risk properties now have value.

How much further do commodity prices have to fall? Potentially no further. Oh, and will Donald Trump really be the next President of the United States?

Our relatively upbeat view on the global economy was a point of discussion. In fact, our view the Fed will still hike three times this year generally garnered wry smiles.

CHINA'S VIEW ON CHINA

In China there is generally more acceptance of the view, when compared with offshore, that policy process will capably deal with the list of challenges. However, there is also doubt.

The recent strong lending and money supply numbers have generated a sense of concern and property prices are back as a source of discussion, particularly in Shanghai and Shenzhen.

Certainly some liquidity based indicators are sending very bullish signals to China's economy at present. At ANZ we are not sure we fully believe the signals but there is clearly some risk the data pulse in China will surprise on the upside for a while, particularly with market expectations skewed in the other direction.

As a general comment the gap between onshore and offshore views has increasingly narrowed. Certainly there is no onshore replication of the most bearish offshore views but very rarely will the onshore sentiment in any economy mirror very bearish external views.

Generally, however, onshore views have become increasingly less gilded and more realistic about China's challenges.

For the first time China's fiscal position was discussed with an element of concern and there was more widespread introspection of China's policy communication efforts in recent months. In any case, the simple point there seems to be an increased critical assessment of onshore conditions is notable to us.

Richard Yetseng is acting chief economist at ANZ.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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