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Box 4: Can a more globally accepted CNY help fund a potential deficit in China?

The counterpoint to many of our arguments on CNY weakness is a that a large, powerful country, with rapidly rising per capita incomes should easily have its external deficit funded by demand for local currency-denominated assets from the rest of the world. The US has enjoyed this 'exorbitant privilege' since the first half of the 20th century, and did not have to make difficult internal choices, because the rest of the world was happy to part with savings to fund its spending. Surely, the 21st century belongs to China, so should there be a similar demand for CNY globally?

China accounts for nearly 23% of global output, and more than 10% of global trade, but the Yuan accounts for less than 1.5% of global transactions, and less than 2% of global reserves (Figure 75). This presents an opportunity for growth in the future, but it must acknowledged that progress has been very slow. According to a recent paper from the RBA3, Australia, a major trading partner for China still invoices only 0.5% of its trade in the Yuan.

The offshore demand for the Yuan has been driven by Chinese companies doing business and issuing debt in Hong Kong. Importantly, this demand seems to have been more speculative than structural in nature. The stock of Yuan held offshore seems closely related with the expectations of its future path (Figure 76). Chinese firms have been willing to adjust the amount of trade settled in the Yuan in line with the strength in the currency.

Another counter-argument is that more open capital account may also be transformative – after all, there should be little doubt that foreign investors are significantly underinvested in Chinese debt and onshore equity markets. This argument is largely playing out with non-resident portfolio inflows accelerating sharply in the past 18 months. However, the flip-side of an open capital account is large resident outflows (which have also doubled in the past three years). As of today, most of China's offshore financial assets are still held by the central bank and, to a lesser extent, by private companies and households. If Chinese outflows as a share of its economy were equal to the average of its developed Asian peers – around 3% of GDP – they would have amounted to US$360 billion last year. CNY is not ready for that at this stage.

Bhanu Baweja and Rohit Arora

3 RMB Internationalisation: Where to Next?

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Figure 77: Despite a sharp pickup in portfolio flows, broad BoP has declined

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Box 5: How sensitive are global assets to a weaker CNY?

We estimate sensitivities of global currencies, stocks, bonds and credit to higher USDCNY, controlling for moves in commodities, global equity and duration asset benchmarks. In this exercise we separated full sample betas (weekly data since 2011) from the spells of CNY weakness, during which USDCNY has trended higher for more than a 12-week period. The latter sample consists of readings from August 2015 to January 2016, October 2016 to January 2017, and June 2018 to October 2018.

The results suggest that in equities (in local currency), some EM commodity exporters and Eurozone (EZ) stocks display a very high beta (1.5) to CNY depreciation. The US beta is much lower (0.7), as shown in Figure 78. China's geographic & economic circle – North Asia, Australia and India – has not shown strong CNY sensitivity (coefficients low and insignificant), rather driven by global factors (both in the full sample and under spells of CNY depreciation). This likely speaks to their lower sensitivity to tighter liquidity and weak risk appetite often having preceded a weaker CNY. The most interesting result was the very limited sensitivity of China A-shares to falling CNY, likely pointing to USDCNY moves not always reflecting domestic sentiment.

Figure 78: Impact of a 1% change in USDCNY: Global equities

Source: Bloomberg, Haver, UBS. Note: Light bars indicate statistically insignificant betas. The periods of concentrated CNY weakness are: i) August 2015 to January 2016, ii) October 2016 to January 2017, iii) June 2018 to October 2018.

Figure 79: Impact of a 1% change in USDCNY : Global currencies

Source: Bloomberg, Haver, UBS. Note: Light bars indicate statistically insignificant betas. The periods of concentrated CNY weakness are: i) August 2015 to January 2016, ii) October 2016 to January 2017, iii) June 2018 to October 2018.

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Box 5: How sensitive are global assets to a weaker CNY? (Continued)

In currencies, commodity exporters and CA-deficit countries naturally screened as the most vulnerable with Malaysia and Indonesia most exposed in Asia. Despite strong links to European equities, the EUR has exhibited a lower beta to USDCNY (0.7) during concentrated CNY weakness. This implies that in periods of stress, the USD is not necessarily the only big relative 'safe haven'; the EUR tends to hold its own (Figure 79).

In credit, US HY and EM sovereigns are most sensitive to CNY weakness, with lesser impact on higher-rated EU HY and EM corporates and little impact on IG markets (Figure 80). With core markets' closing output gaps and current or promised policy normalisation, there is insignificant impact of USDCNY moves on major bond markets; but, given the 2015/16 experience, US fixed income could still be the cleaner relative safe haven (Figure 81).

Relationships and sensitivities are unstable, especially at extremes. That is why it is important to track factors such as China housing weakness, that may accelerate CNY depreciation, or markers that could increase the current very low (near zero) probability of an active devaluation.

However, should the CNY break away weaker from the current level: a) Chinese A-shares themselves may be better positioned than most other markets in EM; b) the degree of EUR weakness may be limited; c) China is unlikely to make any competitiveness gains as most EM currencies react with a high beta; and d) US stocks are best positioned among developed equities to weather the storm.

Bhanu Baweja