Goldman: Capital Flows, Not Case Counts, Matter Most For The Currency

Goldman Sachs note that “China has faced a growing COVID wave and mitigation measures are clearly weighing on demand, production, and the transport sector, and officials have signalled further monetary policy easing ahead. While this would normally be a recipe for currency weakness, we think there are important caveats in China’s case. Most importantly, the COVID crisis has strongly supported China’s capital account through increased demand for goods exports and reduced travel imports (which historically accounted for more than half of China’s total services imports). In addition, potential efforts to diversify international reserves or de-Dollarize commodities trade could further add to already-strong portfolio inflows. On the other hand, investors net sold CNY bonds in February for the first time in a while amid geopolitical risks and EM funds outflows, which highlights the prospect that recent events could also weigh on private sector demand. However, we think it is premature to draw strong conclusions on this, and on our estimates the decline in FX reserves in March was largely driven by valuation effects from the fixed income selloff. Taking these considerations into account, our economists still expect a strong capital account surplus despite higher oil prices, and we see the case for slower but still persistent CNY appreciation, consistent with our longstanding CNY6.30 6-month target for USD/CNY.”