EFTA01459685.pdf

15 January 2016 Global Economic Perspectives: China's evolving FX policy We are not sure, though, that this transitional regime of managing the If the PBOC manages the currency with reference to a basket will last for long. It is one thing for a very RMB with reference to a small very open economy like Singapore to target a certain trajectory for its trade-weighted exchange rate. But having a view on the exchange rate implies basket similar to how some level of constraint on interest rate policy. A rigid peg like that of the HKD Singapore does, they will give implies complete surrender of independent interest rate policy unless capital up policy flexibility. controls are equally rigid. It is one thing for the PBOC to monitor the value of the RMB with respect to its trade-weighted value. But if they try to use that index as a basis for managing the currency's value against other currencies then they are not gaining much more independence of policy than they had before August. Ultimately, the intention appears still to be to move over a reasonable time Ultimately, we think the goal frame to a more flexible exchange rate against all currencies and we think the is genuine currency flexibility. CFETS basket will just be one way to think a little more broadly about the value of the currency. In the near-term, a narrowing interest rate differential versus the USD and Once me overhang of external continuing debt repayment flows will likely continue to pressure the RMB's debt is reduced, it will be external value. The PBOC has more than enough foreign exchange reserves, we think, to make this a stable process. The paramount risk, though, which easier to manage the further motivates the more bearish among the investment community, is that any transition to flexibility. further weakening of the RMB encourages Chinese households to redenominate their RMB assets into foreign currencies. To reduce that risk, the authorities need to do everything they can to reassure It will be important though, investors that they will earn an attractive return on their capital if they invest it that investors gain confidence in China. That requires more than just stabilizing growth. It requires delivering on commitments to reform across a number of dimensions - closing down in their ability to earn a chronically unprofitable SOEs and privatizing others, opening up state- competitive rate of return in dominated sectors to private investment, improving the pricing of capital to China. For that delivery on facilitate capital flows to private rather than SOE firms, strengthening reform pledges is needed. corporate governance so as to improve the returns to investment in listed companies, and so on. March's National People's Congress and the promulgation of the next five year plan would be a good place to start doing that. Michael Spencer (+852) 2203 8303 Page 8 Deutsche Bank Securities Inc. CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0120304 CONFIDENTIAL SDNY_GM_00266488 EFTA01459685