Last week we witnessed a seismic shift in the value of renminbi against the dollar. Where next for the redback? And what will this mean for corporates in China?
In 2014, China’s central bank warned the market to expect more “two-way volatility” in the renminbi over the coming years and, last week, that was exactly what we got.
The week following the Peoples Bank of China’s (PBoC) 2% downward ‘adjustment’ has been something of a rollercoaster for those, like corporates, who trade in the currency. Renminbi – due to its strictly regulated nature – has long been viewed as a currency that does not move much and has relatively low volatility compared with many other currencies globally. But after three days of steep falls, and much speculation that this really represented the first shots in a new round of ‘currency wars’, implied volatility for a three-month options contract against the dollar shot up to 7.93 on Wednesday last week, from 1.5625 just the day before.
Although the volatility has eased somewhat since the PBoC’s subsequent intervention to pare back some of the currency’s losses, the price of ‘USDCNYV3M’ still remains more than double the average of the past year.
Treasurers and other market participants who trade in the currency should be under no illusions. This move may not be a one-off, but rather the birth pangs of what is going to be much less stable renminbi as the PBoC allows market forces play a bigger role in determining the value of the currency moving forward.
A research note published by Deutsche Bank last week warned that a paradigm change is now definitely under way. An example of competitive devaluation it was not, the report argued. Instead the move was merely the latest step in the RMB’s journey to meeting the IMF’s criterion for joining its Special Drawing Rights (SDRs) currency basket (a prerequisite to becoming a fully-fledged international currency).
“What transpired [last week] is not only a seismic shift relative to the currency’s historical movement, it is also a regime shift that warrants recognition that the currency will be more volatile from now on,” the report argued. “As the Chinese authorities allow market forces to play a greater role in determining the value of its currency, precisely at a time when the economy undergoes considerable adjustment and concern about the outlook is heightened, we think it is unlikely that the low currency volatility seen in the past decade will be revisited any time soon.”
Time to hedge?
If this is indeed the beginning of a new, more volatile regime RMB, what then are the implications for corporates doing business in China and, more broadly, those in the Asia-Pacific (APAC) region as a whole?
Firstly, it should be noted that, with respect to Chinese corporates at least, the warning voiced by the PBoC last year did not fall on deaf ears. “There were Chinese corporates who were doing the carry trade – borrowing in dollars and arbitraging the low dollar interest rate – but there is evidence in the market that the trade is unwinding,” David Blair, Managing Director, of Singapore-based corporate treasury consultants Acarate told Treasury Today. “They already started backing off from that quite noticeably after last year’s two-way volatility.”
But prepared or otherwise, the corporate market did not escape unaffected by the move, as the large stock sell-offs seen in pretty much every multinational that sells in China testify. For the corporate treasurers of Chinese and non-Chinese companies alike, industry experts believe a more volatile renminbi is likely to increase the focus on risk management, especially as central bankers in nearby economies look to respond with their own adjustments.
“The effect of RMB on Value-at-Risk (VaR) will go up as a result of this so corporates are more likely to hedge,” says Blair. “But regulatory changes since 2012 making it easier to transfer their exposures and hedge RMB offshore have also been driving increased hedging.”
Carmen Ling, Head of RMB Solutions, Standard Chartered Bank agrees. “As RMB is becoming an international currency with more two-way volatility driven more and more by market forces, corporates and investors would need to rebalance their portfolio and we would expect to see more hedging activities,” she says.
As is often the case though, where there are challenges there are also opportunities. “The depreciation may not be a bad thing for those who are holding US dollar but have a desire to invest in RMB-denominated securities/assets,” Ling adds. “The currency would be supported by a relatively high GDP growth, current account surplus and global demand for the currency itself along with the continued journey of RMB internationalisation.”