The USDCNY rate closed at 6.6481 on June 28, surpassing the previous high of 6.5948 (Jan 11) since the RMB fixing reform in Aug 2015. It feels quite different this time though: The gap between USDCNH and USDCNY is widening again, but nowhere close to where it was in Dec 2015 yet (Figure 1); the CNH 12-month forward points, an indicator of expectation on future RMB trend, still remains low (Figure 2); on the onshore market, the daily FX transaction volumes are still below the Aug/Sep2015 and Dec2015/Jan2016 episodes (Figure 3).

　　In February, when asked about RMB exchange rate reforms, Governor Zhou Xiaochuan of the PBoC said that “advancing reform should pick good windows of opportunities and requires art in timing” (see our report on Feb 14, Messages from PBoC Governor about RMB). In the same interview, he also suggested that the government “can wait a bit and create more favorable conditions for reform”. The recent development, in our view, seems to have opened another window of opportunity for RMB exchange rate reforms.

　　We believe there are several reasons for the relatively calm market responses to recent RMB depreciation. First, much bigger volatilities elsewhere have distracted market attentions from the RMB. While the RMB depreciated some 2.6 percent in the past two months, a very rapid pace by its own standard, it is still by far the most stable SDR basket currency against the USD (Figure 4). Second, the effectiveness of controls on illegal capital outflows by the Chinese government has improved. This can be seen from the much smaller imports discrepancy in recent months (for detailed discussions, please see our report on Feb 29, China: Unveiling the channels of capital outflows). Finally, better communications by the PBoC about its policy intentions have, to certain degrees, helped to reduce the market anxiety.

　　Will the depreciation of RMB help with China’s external competitiveness? The answer is yes, but maybe not as much as many people would think. The PBoC’s RMB index has depreciated by about 5? percent so far this year; our own RMB index points to the same direction, but only shows a 3-percent YTD depreciation (Figure 6). Such difference is mainly due to the Japanese Yen’s strength against the US dollar this year. This in turn is because our RMB index is adjusted for processing-trade bias, and would therefore suggest a smaller competitiveness gain for China from JPY’s appreciation (see our report on Jan 5, A new REER index for RMB). It reflects the fact that Japan is not only an export competitor but also an important supply-chain partner of China.

　　We reiterate our view that, as a baseline scenario, the USDCNY rate will likely reach 7.0 by the end of 2016, a 7.8 percent depreciation compared to end- 2015. Considering recent development, we adjust the probability distribution of annual CNY depreciation vs. USD in 2016: We revise down the chance of RMB appreciation from 10% to 5%, and the chance for depreciation smaller than 5 percent from 25% to 20%; and we revise up the chance for depreciation larger than 10 percent from 10% to 20% (Figure C1).