US Dollar (USD) v/s Chinese Yuan (CNY)

Apurva Prasad
Roll no.8 F-2
PGP-FW-06/08
Indian Inst. Of Planning & Management
 Acknowledgement

It gives me immense pleasure to acknowledge

the opportunity given to me for working on
the project on “Currency tracking” which has
not only allowed me to understand the basic
fundamentals but has also laid down the
platform to understand the application end
of Multinational Business Finance & Forex. I
would like to thank Mrs. Smita Kumar who has
presented her constant support and guidance
which has benefited me to undertake this
project.

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 TABLE OF CONTENTS

Sr.No. TOPICS PAGE No.

1 Acknowledgement 2
2 Table of Contents 3
3 Introduction & Executive Summary 4
4 Snapshot 5
5 China 6
6 USA 9
7 Forex Triggers & Impacts 12
8 Currency Tracking 14
9 PPP Theory 17
10 IFE Theory 18
11 Conclusion 19
12 Webliography 20

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INTRODUCTION & EXECUTIVE SUMMARY

Currency Project gains relevance due to the importance of global economy and
its ramifications on the international financial sector. The approach has been to
integrate the theoretical aspects such as PPP Model, International Fisher Effect,
Technical & Fundamental Analysis, and Quantitative applications along with the
practical developments in Forex/ Multinational Business Finance. The project
attempts to analyse the information and develop an interpretation of the facts
which is characterized by its brevity in representation.

The first part is the snapshot of USD/ CNY. This is followed by a fundamental
outlook on China & USA which includes information and analysis on economic
indicators such as GDP, Interest rates, inflation, Balance of Payment/Trade,
Equity markets. The period for which the currencies USD & CNY have been
tracked ranges from 1st February 2008 to 14th March 2008 (6 weeks). Analysis
has been done on the possible triggers and impact to/on USD/ CNY over a
period of 6 weeks. The currency rates have been analysed by involving technical
views such as Avg. True Range, Support & Resistance Levels. The projections
have been made by taking USD/ CNY spot on 14th March 2007 as the base and
by using PPP Model & IFE Model.

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 SNAPSHOT

From 1994 until mid-2005, the RMB USD/ CNY (1year)

was informally pegged to the USD.
This policy was acclaimed during the
Asian financial crisis of the 1990s, as
it prevented competitive
devaluations. In 2003, the policy
came under criticism by the U.S. as
the dollar's dropping value caused
the value of the renminbi to fall,
which led to pressure from the U.S.
Interest 3M 2Y 10Y
and other countries to increase the Currency Rate Rate Rate Yield Inflation GDP
USD 0.03 0.0276 0.0238 0.0415 0.023 0.025
value of the RMB to encourage
EUR 0.04 0.0462 0.0403 0.0433 0.018 0.022
imports to China and decrease JPY 0.0075 0.0097 0.009 0.0151 -0.001 0.02
GBP 0.0525 0.0593 0.0503 0.0498 0.013 0.029
exports. CAD 0.035 0.037 0.0311 0.0435 0.014 0.029
AUD 0.0725 0.0792 0.076 0.0729 0.03 0.039
In 2005, the peg to the USD was
NZD 0.0825 0.0898 0.0835 0.0783 0.032 0.033
removed. The RMB is now pegged to CHF 0.021 0.0281 0.0265 0.033 0.003 0.036
CNY 0.0225 0.045 0.0382 0.0417 0.087 0.112
a basket of currencies, dominated by
the USD, EUR, JPY and KRW as the From 1-02-2008 to 14-03-2008
Open 7.1828
government continues to reform its Max 7.2135
economic policies and strengthen its Min 7.0000
Close 7.0912
banking systems. Return % -1.28%
σ (Std.Dev.) 0.95%
Gftforex.com
52 week 7.7548/
High/Low 7.1635
Percentage Changes
Daily volatility (High – Low)
Currency Weekly Monthly Yearly %
Pair % Chg % Chg Chg Avg. True Range

AUDUSD 1.14 4.57 18.72 0.18

0.16
EURUSD 2.07 7.55 18.4
0.14
NZDUSD 2.5 3.78 16.82 0.12

GBPUSD 0.32 2.89 4.26 0.1

bps

0.08
USDCNY -0.3 -1.54 -8.45 0.06
DXY -1.88 -6.21 -14.34 0.04
USDJPY -3.48 -8.52 -15.71 0.02
USDCAD -0.13 -0.78 -15.97 0
USDCHF -2.6 -9.93 -17.99 0 50 100 150 200 250
5
300
Days
CHINA

China Economy

 4th Largest Economy by nominal GDP.

 China stands as the 2nd largest economy in the world measured by
domestic PPP (purchasing power) measure, at about $10 trillion USD.
 Economic output for 2006 was $2.68 trillion USD. Its per capita GDP in
2006 was approximately US $2,000 (US $7,600 with PPP), still low by
world standards (110th of 183 nations in 2005), but rising rapidly.
 Since 1978 the People's Republic of China (PRC) government has been
reforming its economy from a Soviet-style centrally planned economy to a
more market-oriented economy while remaining within the political
framework provided by the Communist Party of China.
 Poverty rate down from 53% of population in 1981 to 8% by 2001.

Interest Rate Term Structure

 One-year lending rate is at a nine-year high of 7.47 percent.

 Deposit rate is 4.14 percent, less than half the pace of inflation.

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Inflation (CPI)

 China's inflation accelerated to the fastest pace in 11 years as the worst

snowstorms in half a century disrupted food supplies, adding pressure on
the central bank to raise interest rates.
 Food costs soared 23 percent after blizzards destroyed crops and snarled
transport links, causing shortages.

Gross Domestic Product (GDP YoY)

 China contributed 20 percent of global growth in 2007 - IMF

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Balance Of Trade (MoM)

Shanghai Composite Index

8
UNITED STATES OF AMERICA

US Economy

 GDP of more than $13 trillion constitutes 22 percent of the gross world
product.
 79% of total workforce is employed in the service sector.
 The US is the largest importer of goods and second largest exporter.
Canada, China, Mexico, Japan, and Germany are its top five trading
partners.

Interest Rate Term structure

9
Inflation (CPI YoY)

Gross Domestic Product (GDP YoY)

10
Balance of Trade (MoM)

Dow Jones Industrial Average

 Dow Jones has fallen to November 2006 levels.

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FOREX TRIGGERS & IMPACT USD/ CNY

Week: 1

US Recessionary threats
Federal Reserve cut interest rates by a further 0.50% with the Fed funds cut to
3.00%. The central bank also announced a 0.50% reduction in the discount
rate.
The central bank (China) encouraged faster yuan gains to help curb inflationary
pressure after the fastest appreciation since 2005 in yuan in the month of
January.

Week: 2

Speculations that a stronger currency (yuan) would limit the need for a further
increase in interest rates in China.
Chinese central bank appeared content to let the currency advance at a faster
pace in order to help curb inflationary pressure.

Week:3

Fed Chairman Bernanke continued to warn over the downside risks to the
economy and stated that the Fed would take further action if needed.
The US trade deficit fell to US$58.8bn in December from US$63.1bn the
previous month as exports recovered and imports weakened. The 2007
deficit fell by over US$45bn from the previous year.
Yuan was undermined briefly by the absence of exporters and regained ground
quickly once trading volumes increased.
 The trade position of China remained strong with a US$19.5bn surplus for
January while the IMF called for a faster pace of yuan appreciation.

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Week:4

 Volatility increased by reduced activity in the onshore forwards market as

the regulators tightened control and market makers stopped quoting
prices.

 Chinese inflation issues were a dominant influence with the consumer

inflation rate rising to an 11-year high of 7.1% for January

Week:5

Bernanke warned that the economy was in a weaker condition than before the
2001 recession. Bernanke also stated that the overall inflation risks had risen
over the past few weeks.
Markets continued to price in a further 0.50% cut in interest rates at the March
FOMC.
 The Chinese central bank confirmed its commitment to a tight monetary
policy to combat inflation which reinforced speculation over further yuan
gains.

Week:6

Increase in crude oil prices.

Comments from a central bank of China official that exchange rates should not
be used to fight inflation dampened immediate speculation that faster yuan
appreciation would be encouraged.

CURRENCY TRACKING

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USD/ CNY Ex-Rates

Day Date Open High Low Close

1 Fri Feb 1 2008 7.1828 7.1913 7.181 7.184
2 Mon Feb 4 2008 7.1825 7.1965 7.18 7.1925
3 Tue Feb 5 2008 7.1925 7.1965 7.15 7.1845
4 Wed Feb 6 2008 7.1845 7.1931 7.1835 7.1891
5 Thu Feb 7 2008 7.1891 7.193 7.1835 7.188
6 Fri Feb 8 2008, 7.188 7.193 7.1835 7.1891
7 Mon Feb 11 2008 7.1891 7.1955 7.188 7.1915
8 Tue Feb 12 2008 7.1915 7.1955 7.1835 7.1895
9 Wed Feb 13 2008 7.1895 7.2135 7.18 7.1983
10 Thu Feb 14 2008 7.1983 7.204 7.1835 7.189
11 Fri Feb 15 2008 7.189 7.193 7.1745 7.179
12 Mon Feb 18 2008 7.179 7.1828 7.16 7.166
13 Tue Feb 19 2008 7.166 7.17 7.148 7.148
14 Wed Feb 20 2008 7.1495 7.193 7.1425 7.1435
15 Thu Feb 21 2008 7.1435 7.1548 7.1395 7.1405
16 Fri Feb 22 2008 7.1405 7.1479 7.1395 7.1428
17 Mon Feb 25 2008 7.1428 7.1555 7.1415 7.1515
18 Tue Feb 26 2008 7.1515 7.1642 7.146 7.1565
19 Wed Feb 27 2008 7.1565 7.158 7.1395 7.141
20 Thu Feb 28 2008 7.141 7.141 7.11 7.111
21 Fri Feb 29 2008 7.111 7.1165 7.1025 7.1125
22 Mon Mar 3 2008 7.1125 7.1125 7.1 7.1045
23 Tue Mar 4 2008 7.1045 7.11 7.103 7.107
24 Wed Mar 5 2008 7.107 7.1125 7.105 7.1075
25 Thu Mar 6 2008 7.1085 7.1145 7.1045 7.1055
26 Fri Mar 7 2008 7.1055 7.112 7 7.112
27 Mon Mar 10 2008 7.112 7.1121 7.1025 7.107
28 Tue Mar 11 2008 7.107 7.1105 7.102 7.1037
29 Wed Mar 12 2008 7.1037 7.1075 7.101 7.102
30 Thu Mar 13 2008 7.102 7.102 7.0895 7.091
31 Fri Mar 14 2008 7.091 7.0912 7.083 7.0912

Open 7.1828
Max 7.2135
Min 7.0000
Close 7.0912
Return % -1.28%
σ (Std.Dev.) 0.95%
52 week 7.7548/
High/Low 7.1635

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 USD/CNY 5-day Moving Avg.

7.2500

7.2000
USD/ CNY

7.1500

7.1000

7.0500

7.0000

6.9500
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31

Days

Average True Range (Volatility) Reduced activity

in the onshore
12 forwards market
10

8
bps

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31

Days

Note: (Avg. True Range = High – Low)

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 Resistance & Support levels

7.2500

7.2000

7.1500
R1
USD/CNY

R2
7.1000
S1
7.0500 S2

7.0000

6.9500
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31
Days

Note: Resistance and Support levels have been calculated using Pivot Point.

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PURCHASING POWER PARITY THEORY

et = (1 + ih)^t
eo (1 + if)^t
• Where ih and if indicate price level increases for home currency and
foreign currency
• eo is the CNY value of one unit of home currency U.S.D. at the beginning
of the period and et is the spot exchange rate in period t.

Inflation Rates
US CHINA
2.30% 8.70%

As on 14/03/2007, 1 U.S.D. = 7.737 CNY, where USD is base currency.

et = 7.7370 (1 + 0.0231)^t
(1 + 0.0870)^t
et = 7.7370 (1.023)^1
(1.087)^1
1USD = 7.2815 CNY as per (PPP Theory)

Spot Price 1USD = 7.0912 CNY

Hence it verifies PPP which states that currencies with high rates of inflation
should devalue relative to currencies with low rates of inflation.

INTERNATIONAL FISHER THOERY

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 (1 + rh)^t = et
(1 + rf)^t eo

• Where et is the expected exchange rate in period t

• Where rh and rf , indicate interest rate level for home currency and foreign
currency
• eo is the CNY value of one unit of home currency U.S.D. at the beginning
of the period and et is the spot exchange rate in period t.

The current interest rates prevailing in US and CHINA are as follows.

Interest Rates
US CHINA
2.50% 4.71%

As on 14/03/2007, 1 U.S.D. = 7.737 CNY, where USD is base currency.

(1 + 0.0251) = et
(1 + 0.0471) 7.7370

(1.0251) = et
(1.0471) 7.7370

et = 0.9797 * 7.7370

et 1USD = 7.5734 CNY as per (IFE Theory)

Spot Price 1USD = 7.091 CNY

Therefore, value as on 14th March 2008 should be 1 USD = 7.57444 CNY.

Hence it verifies PPP which states that currencies with high rates of inflation
should devalue relative to currencies with low rates of inflation.

CONCLUSION

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• The 60 degree movement in the CNY post its fixed dollar peg is indicative
that the CNY has been managed carefully by the central bank.
• China will undergo slowdown in its exports due to possible US recession
thereby a slowdown in demand.
• Dollar has weakened against all major currencies due to a possible
recession on account of a collapse in the mortgage and this may couple
into a global contagion.
• CNY will be allowed to further appreciate against USD as China faces
record high inflation.
• The technical view as interpreted from the 31 day PP chart is that
USD/CNY will continue the pattern and approach lower bottoms.
• Standard Deviation of 0.95% over trailing 6 weeks suggests moderate
volatility.
• As per Big Mac Theory CNY is undervalued by ~50% to the dollar (Big
Mac is priced at CNY 11 in Shanghai and US$ 3.11 in Boston).
• Triggers: - FOMC meeting, monthly/quarterly economic indicators, crude
oil prices, and global liquidity situation.
• The Interest Rate Parity suggests a bullish position on CNY and a bearish
position on USD. Strategy:- Short Spot (dollar).

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Webliography
www.tradingeconomics.com

www.advfn.com

www.fxstreet.com

www.oanda.com

www.fxnews.com

www.economictimes.com

www.imf.com

www.bloomberg.com

www.gftforex.com

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