Given the string of political events in the next few months, weakness in the CNY against the USD and the CFETS trade-weighted basket will persist, believe DB analysts. Perry Kojodjojo and team note in their August 11 research piece titled “RMB: One year on….” that exporters are beginning to convert more of their FX proceeds back into RMB, while importers are becoming less active in buying USD.

RMB – The worst performing currency YTD

Releasing their research note on the first anniversary of the shock adjustment to the USD/CNY fixing mechanism on August 11, 2015, the DB analysts point out that the RMB complex has undergone a rollercoaster ride from alarm, to fear of the unknown, to acceptance of a “new norm.” Kojodjojo and colleagues point out that unlike in August and December 2015, the market’s reaction to the last few months’ RMB weakness has largely been calm, both domestically and internationally. They attribute the calmness to three factors: (a) more transparent and communicative FX policy-making, (b) a cocktail of macro-prudential measures and USD sales by authorities, and (c) a more gradual and controlled depreciation move than in the past. The following table captures the list of macro-prudential measures:

Macro-prudential measures

The DB analysts highlight that Asian FX has actually strengthened notably, with the RMB being the worst performer in the region – a clear breakdown in correlation between the RMB and Asian FX – while the onshore/offshore RMB spot spread has been kept relatively narrow.

RMB-worst performing currency

Tracking notable changes in flows since March, the analysts point out that exporters are starting to repatriate a few more USDs, while importers are not actively buying USDs. However, despite the recent success, the DB analysts believe caution is still warranted as domestics’ desire to diversify remains strong. They point out that since August 2015, China has witnessed ~$450 billion of FX loan repayments, which is likely to persist in the coming months. The analysts note that corporates too are actively hedging their FX exposures, primarily via buying USDs or keeping USD proceeds.

RMB still 10% overvalued

Kojodjojo and team point out that besides repayment / hedging activities, other forms of outflows are becoming apparent. Since the government began actively clamping down on outflow channels, domestics are now shifting assets offshore via the portfolio and FDI channels. The DB analysts point out that given concerns about the global outlook and China’s growth outlook, domestic corporates are also actively looking to invest offshore, as can be evidenced from the significant increase in overseas M&A deals in which Chinese corporates are engaging.

Active diversification by domestics

Highlighting some of the measures initiated by authorities to bring in flows, Kojodjojo and team point out that China has started to encourage SOEs and Chinese corporates to issue more USD-denominated bonds and repatriate the proceeds.

The DB analysts point out that going forward, RMB weakness is likely to remain the theme. They believe authorities will remain vigilant on the dynamics of outflows to resist a disorderly FX market. The analysts believe the authorities are unlikely to remove any of the macro-prudential measures they have introduced over the past few months.

The DB analysts add that FX reserves will still need to be actively used to help manage RMB depreciation. The analysts believe that the intent of policymakers is still to allow the RMB to depreciate, particularly against the basket to correct the RMB’s FX overvaluations, albeit on a slow pace. Based on their FX valuation models, the DB analysts argue that the RMB is ~10% overvalued. By assuming that China is still looking to halve this overvaluation in the medium term, the DB analysts believe one should witness CNY against the basket getting close to 90:

RMB-overvalued