UBS dismisses 2012 depreciation fears for RMB

Chief investment strategist Yonghao Pu says there is neither economic nor political rationale to support such concerns, with money outflows behind recent weakness versus the dollar.
UBS dismisses 2012 depreciation fears for RMB

Since the onshore renminbi started trading at a discount in the non-deliverable forward (NDF) market in late September, concern has grown that China's currency will start to depreciate, denting the appeal of RMB-denominated securities.

However, that is not the view of UBS Wealth Management, which argues that the RMB will continue to appreciate next year, albeit at a slower rate.

“RMB depreciation lacks both economic and political condition,” says Yonghao Pu, the Swiss banking division's chief investment strategist. “But the appreciation pressure on the RMB has been eased. Our house view is that the CNY will appreciate to 6.3 per US dollar in three months and 6.1 per US dollar in 12 months.”

From an economic perspective, as long as China continues to run a current account surplus, the RMB will not be under depreciation pressure, Pu points out. Politically, with 2012 an election year in the US, he also notes that both the Democrat and Republican parties will continue to exert pressure on China to let its currency appreciate.

Additionally, a lower inflation rate forecast does not support currency depreciation in China either. UBS tips the CPI index to increase by 3.5% on average in 2012, lower than 5.5% this year, according to the Blue Book of China's Economy released by the Chinese Academy of Social Sciences (CASS) which has forecast that inflation will ease to 4.6% next year.

In the first 10 months this year, except for January and February when the CPI index was up by 4.9%, the following eight months saw the CPI index rise above 5%. It peaked at 6.5% in July and dropped to 5.5% in October.

Pu points out that as the pork price declines and with the prospect of harvest almost certain, the prices of core components of CPI, staple foods and agricultural produce, will come down.

The only uncertain factor is the oil price, he notes. China's dependence on crude oil imports had reached 55.2% by the end of first half of 2011, according to data from the nation's Ministry of Industry and Information Technology.

Pu believes that the RMB’s recent weakness against the US dollar relates to money outflows. “There is hot money from overseas leaving China to their home countries, while Chinese investors are tempted to purchase undervalued assets overseas.”

Forecasting that GDP growth will moderate to 8% next year (lower than CASS’s 8.9% forecast), Pu believes investment and domestic consumption will be the key factors fuelling economic growth while net exports will not contribute positively as external demand from developed countries, especially Europe, will continue to decline.

Facing a deteriorating global economy, Pu expects the Beijing government to adopt an expansionary fiscal policy to stimulate investment next year. “In the first 10 months of 2011, the Chinese government’s tax revenue increased about 28%, leaving ample room to increase expenditure.”

However, he notes that possible stimulus measures will not be the same as in 2009 when the Rmb4 trillion package fostered asset price bubbles. “Rather increased spending will be intended to support sectors such as agriculture, hydrology, rural infrastructure and transportation.”

In terms of monetary policy, Pu does not think an interest rate cut is necessary as the real interest rate has been negative. Compared with inflation above 5%, the one-year deposit rate now is 3.5% and the lending rate (one year) 6.56%. That said, he believes the required reverse ratio (RRR) will be reduced by two or three times in 2012, enabling banks to lend more.

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