Challenging backdrop calls for substantially weaker CNY

China's recent FX measures have given markets a feast for thought and created new opportunities in FX markets as year-end approaches. There is still a lively debate about what the August 11 measures, and the FX interventions that followed, imply for the value of the yuan and for the current and future pace of economic activity. 

"We have been bearish on Chinese growth relative to the consensus and therefore expected USDCNH to rise above forwards. But we believe that recent measures imply official acknowledgement that trend growth has finally been hit by the build-up in imbalances around an investment-/manufacturing-led growth model that no longer can be sustained", said Barclays in a research note to its client. 

This challenging backdrop is believed to call for a more flexible currency regime, therefore, USDCNY is targeted at 6.80 by year-end, foresees Barclays. Although this is a weaker CNY than consensus expectations and forwards, it is not significant in REER terms. 

"A competitive depreciation would not be in China's best interest, as estimates suggest that a 10% REER CNY depreciation would add only 30-40bp to growth. A decline of at least 20% in the CNY REER would be needed for this policy to have a meaningful effect, which would probably imply a very large depreciation versus the USD, given that other trading partners would likely respond with similar FX policies. A much larger CNY depreciation could pose serious financial stability risks that government officials may prefer to avoid. Indeed, our forecasts imply only a REER CNY depreciation of 2.3% by year-end", argues Barclays.