CIMB Principal Asset Management Berhad
June 25, 2010


I   The RMB Revaluation

Last weekend, China announced that it would reform the exchange rate regime and increase the flexibility of the RMB exchange rate.  While this statement is coded in its intent, market participants are reading it as a signal that the People's Bank of China (PBOC) is ready to resume the crawling peg of the RMB against the US Dollar.  This was actually started in July 2005 but was interrupted by the global financial crisis in 2008.  Credit Suisse expects about a 2.0% appreciation against the US Dollar by the end of the year and a 4-5% appreciation over 12 months.  Xi Jinping, Vice President, reportedly said during his trip to New Zealand that China was prepared to allow its exchange rate to appreciate 15-20% over the next 5 years.


Not everybody agrees.

Other views are more skeptical.  The counter argument is that the timing of the move is clearly targeted at the G20 summit in Seoul this weekend.  There is no real change from previous statements of the PBOC.  Leaders in Beijing are cautious over global growth prospects given sovereign debt problems in Europe.  At a Credit Suisse conference in China recently, Mr Song Hongbing, the author of "Currency War", even included the United States as having the same problem, as it essentially converted private sector debt into sovereign debt when it rescued the US financial system.

We should state that we concur witht the earlier view, while we also agree with Mr Song that both Europe and the United States have sovereign debt problems.  That is the likely reason why gold continues to appreciate, but that is a story for another day.


What are the implications of the appreciation of the RMB?
At the macro level,

* It has been known for some time, that China is tweaking its economic growth model to be less reliant on    exports and more dependent upon domestic consumption.  At present, domestic consumption accounts for only 32% of GDP compared to 71% in the United States. 
*  Exports, on the other hand, will be more expensive.  Coupled with the recent increases in labor costs, exporters will forced to automate and move up the value chain to compete or lose out.  (We should add that Malaysia cannot continue to depend upon a cheap currency for export competitiveness as well.)

At the micro level,

*   The obvious gainers will be companies with operations in China but with the US Dollar as the reporting currency.  These include Standard Chartered Bank (22% of revenues from China); Swatch(27%); HSBC (17%) and Volkswagen (16%).  The China oil companies will also benefir as crude oil imports costs will be lower.  (Source: Credit Suisse)
*   Exporters in the region that compete head on with China will also benefit.  That will include advanced economies like Korea, Japan and Singapore to the more labor intensive countries like Indonesia, Vietnam and Malaysia.  Margins are likely to expand.
*   The losers will be China exporters, in the short-term, as they lose price competitiveness.  Others will include companies that source from China.  Textile companies based in Hong Kong are a prime example.


Self Interest first.

Finally, there is a question that needs to be asked: "Is the RMB revaluation a sign that China is concerned over inflation?"  The answer is we do not know.  But there is a nagging suspicion, that apart from the timing of this revaluation, the Chinese government has never succumbed to international pressure to act against its self interest, and so it is with this decision.  At last look, inflation in China was 3.1% and the expectation is that it will rise to 5.5% by year end.  (Source: Credit Suisse)




II   China recognizes Malaysia as an approved investment destination under the Qualified Domestic Institutional Investor (QDII) Scheme

We are afraid the market is getting a little too optimistic in its expectation of an inflow of funds.

The impact is likely to be muted.

It has been reported (Source: CLSA) that QDII funds total US$47.7bn with US$27.8bn invested so far.  Assuming that 2.5% (similar to Singapore weighting) of the remainder is dedicated to Malaysia, the amount only US0.5bn or RM1.59bn, which is quite small compared to Bursa Malaysia's market capitalization of US$127bn or the Malaysian government bonds outstanding of US$126bn (Source: Credit Suisse).

Still, one could argue that Malaysia does provide some attractions to mainland China investors mainly from its exposure to Plantations.


What was the experience elsewhere?

We must caution readers on expecting too much.  The Hang Seng Index benefitted when Hong Kong was approved as a QDII destination but the impact was muted where the Straits Times Index (Singapore) and KOSPI (Korea) were concerned.


There is a silver lining

However, Chinese institutions can now appoint Malaysian fund managers to manage their funds, which is new area of business for them.  In addition, they will be allowed to invest directly in unit trust funds in Malaysia.

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