Transcript One year RMB NDF premium/discount to the spot

RMB and CEPA
Stephen Yan-Leung Cheung
Professor (Chair) of Finance
City University of Hong Kong
Contents
• Current debates on RMB
• CEPA’s impacts on Hong Kong
• Others
Stephen Cheung
City University of Hong Kong
2
Variable
1.The spot exchange rate, S, is the rate of
exchange of 2 currencies for immediate
delivery.
2.The forward exchange rate, F, is the rate
of exchange rate of 2 currencies on one
date for delivery at a future specified date.
For example, the Euro/US dollars forward
exchange rate for delivery in one year is
1.3 US$ for 1 Euro
Stephen Cheung
City University of Hong Kong
3
• The objective is to examine several key
international parity relationships, such as
interest rate parity and purchasing power
parity.
Stephen Cheung
City University of Hong Kong
4
Outline
•
•
•
•
Interest Rate Parity
Purchasing Power Parity
The Fisher Effects
Forecasting Exchange Rates
Stephen Cheung
City University of Hong Kong
5
Interest Rate Parity
• Interest Rate Parity Defined
• Covered Interest Arbitrage
• Interest Rate Parity & Exchange Rate
Determination
• Reasons for Deviations from Interest Rate
Parity
Stephen Cheung
City University of Hong Kong
6
Interest Rate Parity Defined
Suppose you have $100,000 to invest for one year.
You can do one of two things:
1. Invest in the U.S. at interest rate i$. After one year
you will receive
Face Value + Interest =
$100,000 + $100,000 * ius =
$100,000(1 + ius)
Stephen Cheung
City University of Hong Kong
7
Interest Rate Parity Defined
2. Trade your dollars for yen at the spot rate. You will
receive $100,000 / S($/¥) in ¥.
Then, invest this sum in Japan at i¥ . After one year
you expect to receive
[$100,000 / S($/¥)] * (1 + i¥)
Hedge your exchange rate risk by selling the future
value of the Japanese investment forward. You
will receive now
[$100,000 / S($/¥)](1 + i¥) * F($/¥) =
$100,000[F($/¥)/S($/¥)](1 + i¥)
Stephen Cheung
City University of Hong Kong
8
Interest Rate Parity Defined
Since both of these investments (1) and (2)
have the same risk, they must have the
same future value—otherwise an arbitrage
would exist. Therefore,
Investing in U.S. = Investing in Japan
$100,000[F($/¥)/S($/¥)](1 + i¥) = $100,000(1 + ius)
[F($/¥)/S($/¥)](1 + i¥) = (1 + ius)
Stephen Cheung
City University of Hong Kong
9
Interest Rate Parity Defined
Formally,
[ F($/¥) / S($/¥) ] (1 + i¥) = (1 + ius)
or
1  i$ F

1  i¥ S
IRP is sometimes approximated as
(F- S)
(i$ -i¥ ) 
S
Stephen Cheung
City University of Hong Kong
10
Interest Rate Parity Defined
• IRP is an arbitrage condition.
• If IRP did not hold, then it would be possible
for a smart trader to make unlimited amounts
of money exploiting the arbitrage opportunity.
• This would change F, S, and i until the
condition is restored.
• Since we don’t typically observe persistent
arbitrage conditions, we can safely assume
that IRP holds.
Stephen Cheung
City University of Hong Kong
11
Example
If IRP failed to hold, an arbitrage opportunity
would exist. A trader could engage in
“Covered Interest Arbitrage”. It’s easiest to
see this in the form of an example.
Stephen Cheung
City University of Hong Kong
12
Example
Consider the following set of foreign and
domestic interest rates and spot and
forward exchange rates.
Spot exchange rate
S($/£) = $1.25/£
360-day forward rate F360($/£) = $1.20/£
U.S. interest rate
i$ = 7.10%
British interest rate
i£ = 11.56%
Stephen Cheung
City University of Hong Kong
13
Example (continued)
A trader with $1,000 to invest could invest in
the U.S. In one year his investment will be
worth
$1,000(1+ i$) =
$1,000(1+0.071) =
$1,000(1.071) =
$1,071
Stephen Cheung
City University of Hong Kong
14
Example (continued)
Alternatively, this trader could exchange $1,000
for £ at the prevailing spot rate, receiving
$1,000 ÷ $1.25/£ = £800
Invest this amount in Britain at i£ = 11.56% for
one year, expecting to receive
£800(1+ i£) =
£800 (1+0.1156) =
£800 (1.1156) =
£892.48
Stephen Cheung
City University of Hong Kong
15
Example (continued)
Sell forward now the £892.48 that he
expects to receive in one year. He will
receive now
£892.48 x F360($/£) =
£892.48 x $1.20/£ =
$1,071
This is the same as what he would expect to
receive if he invested the money in the U.S.
Stephen Cheung
City University of Hong Kong
16
Reasons for Deviations from
IRP
• Transactions Costs
– The interest rate available to an arbitrageur for
borrowing, ib,may exceed the rate he can lend at,
il .
– There may be bid-ask spreads to overcome
• Capital Controls
– Governments sometimes restrict import and
export of money through taxes or outright bans.
Stephen Cheung
City University of Hong Kong
17
Purchasing Power Parity
• Purchasing Power Parity and Exchange
Rate Determination
• Evidence on PPP
Stephen Cheung
City University of Hong Kong
18
Purchasing Power Parity and
Exchange Rate Determination
• The exchange rate between two
currencies should equal the ratio of the
countries’ price levels.
S($/£) = P$ P£
• If U.S. inflation is 5% and U.K. inflation is
8%, the pound should depreciate by 3%.
Stephen Cheung
City University of Hong Kong
19
Evidence on PPP
• PPP probably doesn’t hold precisely in the
real world, because commodity arbitrage is
difficult
– Transactions costs (e.g. shipping costs)
– Controls (e.g. tariffs and quotas).
– Non-tradable goods.
• Also, PPP ignores capital flows, which
nowadays seem to be more important than
trade flows.
• PPP-determined exchange rates still provide
a valuable benchmark.
Stephen Cheung
City University of Hong Kong
20
Stephen Cheung
City University of Hong Kong
21
Fundamental Approach
• Involves econometrics to develop models
that use a variety of explanatory variables.
This involves three steps:
– step 1: Estimate the structural model.
– step 2: Estimate future parameter values.
– step 3: Use the model to develop forecasts.
• The downside is that fundamental models do
not work any better than the forward rate
model or the random walk model.
Stephen Cheung
City University of Hong Kong
22
Technical Approach
• Technical analysis looks for patterns in the
past behavior of exchange rates.
• Clearly it is based upon the premise that
history repeats itself.
• Thus it is at odds with the Efficient Markets
Hypothesis.
Stephen Cheung
City University of Hong Kong
23
Performance of the Forecasters
• Forecasting is difficult, especially with
regard to the future.
• As a whole, forecasters cannot do a better
job of forecasting future exchange rates
than the forward rate.
• The founder of Forbes Magazine once said:
“You can make more money selling advice
than following it.”
Stephen Cheung
City University of Hong Kong
24
Current Debates on RMB
• Should RMB appreciate?
• What are the impact on China if RMB
appreciates?
• What to be done?
Stephen Cheung
City University of Hong Kong
25
One year RMB NDF
premium/discount to the spot
Stephen Cheung
City University of Hong Kong
26
1. Should RMB appreciate?
• Global economy is not doing well, US dollar
depreciated, Chinese foreign reserves increase.
– In February, G7 meeting Japanese FS claimed
“ Chinese cheap products are the main reason for the
slow down of Japan and global economy”, blame on
RMB’S undervalue.
– In May, G8 meeting, US FS raised the issue of RMB’s
appreciation.
– US’s political pressure, next year, US presidential
election, this will definitely be an issue.
Stephen Cheung
City University of Hong Kong
27
Changes of RMB cross rates in the
past ten years
Against
01/9301/94
01/9410/97
10/9701/02
01/0201/03
01/9301/03
01/9401/03
140/9701/03
Euro
-28.96%
2.75%
33.24% -20.30%
-22.49%
9.12%
6.20%
Yen
-42.50%
16.18%
11.88% -10.93%
-33.42%
15.78%
-0.34%
Korean Won
-32.08%
24.48%
35.99% -10.84%
2.50%
50.92%
21.24%
New TW Dollar
-31.10%
21.34%
14.08%
-0.58%
-5.17%
37.63%
13.42%
Singapore
Dollar
-35.82%
3.50%
17.10%
- 5.65%
-26.61%
14.35%
10.48%
Malaysia Ringgit
-30.04%
26.70%
13.70%
-0.02%
0.76%
44.03%
13.68%
Philippine Peso
-25.79%
32.96%
46.68%
5.08%
52.08%
104.94%
54.13%
Thai Baht
-34.04%
65.08%
9.92%
-2.89%
16.22%
76.21%
6.74%
Stephen Cheung
City University of Hong Kong
28
External
Reasons
• Chinese deliberately undervalue RMB to
maintain export’s competitiveness.
• China’s trade surplus, foreign reserves up.
• China exports deflation because of
cheaper products. RMB’s appreciation will
eliminate deflation.
Stephen Cheung
City University of Hong Kong
29
External
Arguments
A. China’s export increase is NOT because
of the low exchange rate. There is a
continued improvement on product quality,
low cost and skilled labor force,
technological transfer from MNCs.
– China’s product’s elasticity on exchange rate
is 0.2. If RMB rate depreciates 1%, export
will increase by 0.2%
– RMB’s undervalue will not increase export
MUCH.
Stephen Cheung
City University of Hong Kong
30
• Account Werner International Consultancy
Limited
– In 2000, hourly wage of textile industry in
China is 0.69 US$, 1/37 of Japan, 1/20 of US
and Europe and 1/8 of Korea. For automobile
industry, the China’s labor/cost per hour is
1.7% of Japan and US
Stephen Cheung
City University of Hong Kong
31
2002 U.S. Goods Exports, Imports and
Trade Balance, by Region Millions of dollars,
on a Census basis not seasonally adjusted
Total
North America
Western Europe
-470,104
-86,962
-89,218
Eastern Europe, Former Soviet Reps.
Pacific Rim
-8,283
-215,005
South/Central America
OPEC
Other countries
-17,902
-34,482
-36,367
Source: U.S. Commerce Department, February 2003
Stephen Cheung
City University of Hong Kong
32
External
B. Chinese cheap products export
“deflation”; the main reason for global
economy’s slowdown.
– China’s trade, 5% of the global trade
– China’s export to Japan, accounts for 2% of
the Japan’s GDP
– Mostly low-end products
– Imported materials
– Should not be responsible for the global
economy’s slowdown
Stephen Cheung
City University of Hong Kong
33
Imports and exports of China by
main countries in 2003 quarter 1
Country
(Region)
Dollars (billion USD)
% change when compare
with 2002 Quarter 1
Trade Balance
Export
Import
Export
Import
Export-Import
Japan
12.70
15.74
2.39
5.55
-3.04
US
17.66
7.93
3.40
3.99
9.73
Europe
14.14
11.08
4.19
3.84
3.06
Hong Kong
14.89
2.48
2.91
1.50
12.41
South East Asia
6.14
9.70
3.02
6.43
-3.56
Korea
4.02
9.16
2.80
3.77
51.4
Taiwan
1.84
10.28
4.50
2.18
-8.44
Russia
1.08
2.18
6.75
2.11
-1.10
Australia
1.25
1.50
3.67
2.19
-0.25
Canada
1.14
1.02
3.22
21.9
1.2
Source: Customs General Administration People’s Republic of China
Stephen Cheung
City University of Hong Kong
34
US productivity and related data in manufacturing,
percentage changes, 1949-2000 (percent per year)
19492000
19491973
19731979
19791990
19901995
19952000
19992000
Productivity
Multifactor productivity1
1.2
1.5
-0.6
1.1
1.3
2.1
1.9
Output per hour of all persons
2.8
2.6
2.2
2.6
3.3
4.3
4.0
-0.4
0.0
-2.1
-0.8
0.6
0.1
-1.2
3.3
4.0
2.5
2.0
3.1
4.1
2.5
Hours 2
0.5
1.4
0.3
-0.7
-0.1
-0.2
-1.4
Capital services
3.7
4.0
4.7
2.8
2.5
4.0
3.8
Energy
2.7
4.9
0.8
0.3
1.8
0.5
2.8
Non-energy
3.0
2.3
6.2
1.7
3.5
4.5
0.9
Purchased business services
2.8
5.1
5.4
1.7
3.5
1.0
1.0
Combined inputs 3
2.1
2.4
3.1
0.9
1.8
2.0
0.7
Output per unit of capital services
Sectoral output
Inputs
Materials
Source: The Bureau of Labor Statistics of the U.S. Department of Labor
Stephen Cheung
City University of Hong Kong
35
Internal Reasons
•
Despite high economic growth, banking
system is fragile, income gap, and SOEs
reform
a) Unemployment problem. despite high
economic growth, unemployment is stills a
big problem because of the population
growth and surplus labor form the rural
areas. The fast growth in export-related
industries ease part of the problem
Stephen Cheung
City University of Hong Kong
36
Internal Reasons
b) Fragile banking system, NPL problem,
capital adequacy ratio low (international
level). In 2 years, according to WTO, China
will have to open the bank industry, more
competition. RMB’s appreciation will worsen
the problem.
c) SOEs reform, in 2002, more than 30%
SOEs record profit, the total was 260 billion
RMB. If RMB appreciates, this will worsen
the SOEs profitability
Stephen Cheung
City University of Hong Kong
37
2. Impacts on Chinese Economy
a) Worsen the investment environment,
slow down the inflow of FDI. This will
encourage the inflow of hot money to
speculate on the RMB’s further
appreciation
b) Negative impacts on under-privileged
sectors, such as agricultural, mining
(steel) business.
Stephen Cheung
City University of Hong Kong
38
2. Impacts on Chinese Economy
c) Increase deflation pressure. RMB’s
appreciation may increase import and
decrease export. This may worsen the
oversupply problem in China.
d) More importantly, RMB appreciates will
leads to the RMB’s exchange rate
instability and expectation of further
appreciation, which may cause more
inflow of funds for more speculation.
Stephen Cheung
City University of Hong Kong
39
2. Impacts on Chinese Economy
e) RMB’s appreciation may not be
advantages fro US & Japan.
– China’s GDP accounts for 3.5% of
global economy.
– China trade accounts for 5% of global
trade
– During the past decade, China’s cheap
products contribute to the US’s high
growth rate and low inflation rate,
RMS’s appreciates may increase cost
of US import and inflation will return
Stephen Cheung
City University of Hong Kong
40
– China has been the most important US
treasury securities investor. Up to June
2003, China has bought 122.5 billion US
government bonds, accounts for 1/3 of
China’s reserves
– China contributes to the US’s
refinancing activities
– Maintaining the US’s low interest rate
environment
– RMB’s appreciates demand for US’s
securities declines
Stephen Cheung
City University of Hong Kong
41
2. Impacts on Chinese Economy
• RMB appreciates may ease the pressure for
US SMEs (manufacturing).
– Bad for MNCs. MNCs accounts for 54% of
the China’s export.
– RMB appreciates may have negative
impacts on investment, purchasing and
production, e.g. Walmart, China’s products
accounts for 70% of its products.
Stephen Cheung
City University of Hong Kong
42
Short-term measures
(current account)
• Encourage more imports; raw materials
and oil. Reduce subsidies for export
industries.
• Allow enterprise to keep more foreign
reserves.
Stephen Cheung
City University of Hong Kong
43
Short-term measures
(capital account)
• 480 billion US$ of FDI during the past 2
decades.
– For strategic areas, such as Western part of
China
– Encourage more hi-tech or more value-added
related
• QFII, restriction on short-term portfolio
investment. Tobin case may be used.
• Regulatory control on hot money.
Stephen Cheung
City University of Hong Kong
44
Conclusions
• In 2003, China’s export is 38 billion US$,
ranked after US & Germany. Foreign
reserves exceeded 365 billion US$. How
to use this reserve efficiently.
• Encourage Mainland enterprises for
overseas expansions.
• QDII
Stephen Cheung
City University of Hong Kong
45
International (regional) Integration
1. Economic integration enhance
cooperation in economic and trade
activities among different economies. E.g.
Europe, Latin America, North America
and South-Ease Asia.
a. Free Trade Area
– Remove (most) trade barriers, e.g. tariff to
promote trade among member economies, such
as NAFTA, ASEAN
Stephen Cheung
City University of Hong Kong
46
International (regional) Integration
b. Customs Union
–
c.
Member economies are required to remove all tariff,
have a unified trade policy, e.g. EC and Caribbean
EC
Common Market
–
–
–
No trade barriers among member economies
Unified trade policy
Factors of Production can move freely among
members economies , e.g. EU before Euro
d. Economic Union
–
Common market features and a single currency (EU)
Stephen Cheung
City University of Hong Kong
47
International (regional) Integration
e. Political Union
–
One step further the economic integration, having
one single government, e.g. U.S.A.
Step-by-step
Lower tariff
→ eliminated trade barriers
→ Free-flow of factors of production
→ Unified tariff and external trade policies
→ Unified currency, fiscal policy, tax, exchange, form of
economic union
→ One single government
Stephen Cheung
City University of Hong Kong
48
International (regional) Integration
Experiences
• Win-win situation
• Create more opportunities for member
economies
• Mobility of factor of productions,
comparative advantages
• Resources allocation becomes more
efficient.
• Better over whole economic performance
Stephen Cheung
City University of Hong Kong
49
HK & Mainland
economic cooperation
• Before CEPA
– Private sector
– Barriers; tariffs; bounder; little mobility on
factors of production
Stephen Cheung
City University of Hong Kong
50
HK & Mainland
economic cooperation
• CEPA
– No tariffs on selected products made in HK
– Market access fro HK services industries
– Plus telecommunication, definition of ‘HK company’
and ‘made in HK’
– Long-term goal is to open up the mainland market
and to enhance free flow of factors of production
• CEPA is considered to be more than NAFTA but
less than EU.
Stephen Cheung
City University of Hong Kong
51
HK & Mainland
economic cooperation
•
CEPA will bring long-term impacts on the Pearl
Delta region
1. Individual Travel will enhance human and capital
flow
2. Further infrastructure project cooperation in the
region, e.g. 西部通道,港珠澳大橋及粵港澳高速鐵路
3. RMB business
4. Macro-economic policy cooperation
–
Cooperation between HK & provincial governments
5. Enhance cooperation on industries
–
Stephen Cheung
HK servicing industries, such as financial industries,
high value-added manufacturing industries
City University of Hong Kong
52
Hong Kong’s advantages
•
•
•
•
•
Legal System
Intellectual property right protection
Information system
English
International network
Stephen Cheung
City University of Hong Kong
53
Industrial structure of Hong Kong (%)
Year
1980
1985
1990
1995
2000
2001
Manufacturing
Industry
23.6
22
17.5
8.3
5.8
5.2
Services
industry
67.3
69.5
74.4
83.7
85.7
86.5
Others
9.1
8.5
8.1
8
8.5
8.3
Source: Hong Kong Census and Statistical Department
Stephen Cheung
City University of Hong Kong
54
Division of Labor
1. Between Hong Kong and Pearl Delta
Region
a. Hong Kong
–
–
–
–
–
–
Stephen Cheung
Product development
Design
Trading
Logistic
Management
Supply chain management
City University of Hong Kong
55
Division of Labor
b. Pearl Delta Region
– Manufacturing process
– Some R&D
– Purchasing
Stephen Cheung
City University of Hong Kong
56
Division of Labor
1. Between Hong Kong and Shanghai
a. Hong Kong
–
–
–
–
Stephen Cheung
Private banking services
Funds management
Funds raising for enterprise
Derivative instruments
City University of Hong Kong
57
Comparison of economic structure
in small and medium economy
Primary
Production
Secondary
Production
Tertiary
Production
Hong Kong (2001)
0%
14%
86%
Singapore (2001)
0%
33%
67%
Taiwan (2000)
2%
32%
66%
South Korea (2002)
4%
42%
54%
Switzerland (2002)
2%
34%
64%
New Zealand (1999)
9%
23%
69%
Ireland (2001)
4%
36%
60%
Sweden (2001)
2%
29%
69%
Norway (2000)
2%
31%
67%
Source: The world fact book 2002, CIA, United States
Stephen Cheung
City University of Hong Kong
58
Division of Labor
b. Shanghai
– Trade finance
– Retail banking
– Consumer banking
Stephen Cheung
City University of Hong Kong
59
• CEPA aims at promoting more mobility of
FPs between Hong Kong and Mainland, to
enable Hong Kong to become ‘part of
Chinese economic system’.
Stephen Cheung
City University of Hong Kong
60
Conclusion
•
•
•
•
•
•
Further mobility of FPs
Cross-border infrastructural projects
Legal system integration
Financial regulation
Recognition of professional qualification
Environmental and security issues
Stephen Cheung
City University of Hong Kong
61