The CNY has appreciated 8.8% vs. the USD and 10% vs. the HKD since 2017, while it remained largely flat vis-a-vis the trade weighted basket. In retrospect, we have witnessed the fastest CNY appreciation in a 12-month stretch in the past decade. In this report, we provide a top-down analysis on the macro implications of the exchange rate moves, including the potential sectoral “winners” and “losers”.

On the merchandise trade front, we see limited overall impact of the CNY move on China’s total export and import volume growth, since the CNY effective exchange rate was largely unchanged. However, there are clear “winners” and “losers” depending on the cost and revenue structure of the specific industries/companies. For example, some of the paper manufacturers stand to benefit given their USD cost base and CNY revenue source. On the flip side, selected exporters of electronic products, textiles, furniture, automobiles, machinery, toys, and footwear may suffer margin compression due to their high exposure to the US market.

On the service trade front, rising nominal income in China, coupled with local currency depreciation vs. the CNY, will likely drive a meaningful pick-up in tourism revenue in Hong Kong and Macao, and to a lesser extent, Japan and the US.  

In regards to financial expenses, “borrowers” of USD-denominated debt will likely benefit, while the “hoarders” of the USD may suffer sizable losses. Industries that have borrowed the most in FX include financial institutions, property developers, energy companies, IPPs, and airlines. On the other hand, we suspect that the biggest “hoarders” of unsettled FX proceeds may overlap with the top export sectors.

Continued strength of the CNY sets the foundation for a more affirmative outlook for financial opening-up, as well as further progress in RMB internationalization this year. In this regard, financial institutions with cross-broader capabilities stand to benefit. We raised our 2018 year-end USD/CNY forecast to 6.18 from 6.28, on the back of our downward adjustment of 2018 USD index forecast. Against this backdrop, we expect some of the ad-hoc capital control measures to be lifted, especially those concerning individual FX usage.

However, going forward, a potential reversal of the CNY depreciation expectation may add to the incentives for currency arbitrage/mismatch by the corporate sector, posting renewed challenges of cross-border capital flow management on the macro level, and sizable financial expense fluctuation on the corporate level. It is worth noting that the shares on the corporate balance sheet for both FX “hoarding” and FX debt exposure have grown substantially since 2016, indicating rising tendency of FX “arbitrage”.