Why analysts are confident that RMB depreciation's direct impact is modest

But they're still scared of the "indirect impact".

On August 11, the People’s Bank of China (PBOC) changed the way it sets the daily mid-rate for the renminbi (RMB) – from which the currency is allowed to fluctuate up to 2% in either direction – by referring to the closing rate of the interbank foreign exchange market on the previous day.

According to a research note from Hang Seng Bank, further, the RMB dropped by about 3% against the US dollar (USD) in the two days immediately following the announcement but has since stabilised following an announcement by the PBOC on August 13 that there was no basis for the RMB to continue to depreciate.

On retail sales, if depreciation in the RMB persists, it is likely to be negative for Hong Kong retail sales as goods being sold to tourists from mainland China may become more expensive. For the first seven months of the year, Mainland tourists accounted for 78% of total visitor arrivals.

In 2014, about 80% of tourist spending came from Mainland visitors. Retail sales only covers consumer spending on goods and does not include spending on services such as entertainment and transport. In this regard, tourist spending on shopping is included in retail sales, but tourist spending on entertainment, tours and similar items is not.

Hang Seng Bank's calculations suggest that spending by Mainland visitors as covered by tourist spending and retail sales represented about 38% of Hong Kong’s retail sales in 2014.

If the RMB weakens by 5% in a year compared with the rate before the August 11 announcement and Mainland tourists cut their spending by the same percentage, then Hong Kong’s retail sales will likely drop by 1.9 percentage points.

In this regard, the direct impact of the RMB depreciation is modest. That said, local consumer sentiment and hence household consumption may be adversely affected by the reduction in spending by Mainland tourists and effect of this indirect impact is hard to estimate.

Here's more from Hang Seng Bank:

On trade: The RMB’s persistent weakness may also influence the Hong Kong economy through the trade channel. A weaker RMB may boost the Mainland’s net exports, which, in turn, may lead to a rise in Hong Kong’s re-exports from the Mainland but a decline in Hong Kong’s domestic exports and re-exports to the Mainland.

The net effect, while uncertain, is likely to be positive as Hong Kong’s re-exports from the Mainland have been bigger in size than Hong Kong’s total exports to the Mainland over recent years. The economic benefits would be even greater if we consider that the profit margins generated from re-exports from the Mainland are higher than those generated from re-exports to the Mainland.

Data for the recent past is not available, but figures in previous years show that the former had consistently been more than double the latter and thus we can safely assume that this is still more or less true.

RMB depreciation may boost trade but dampen retail sales in Hong Kong. The former may contribute to faster gross domestic product (GDP) growth in the city, but the implication of the latter is ambiguous as Hong Kong imports most of its goods from abroad.

In other words, Hong Kong’s retail sales and imports of goods could both decline on the back of RMB depreciation. In the calculation of GDP, tourist spending is counted as net exports of travel services, which represented only 5.6% of GDP in 2014. As such, the impact of the RMB’s decline on GDP through tourist spending is likely to be small. Overall, therefore, RMB depreciation may have a positive direct impact on the Hong Kong economy.

But we reiterate that the indirect impact is hard to estimate. For example, a fall in spending by Mainland visitors may hit local consumer confidence, and a decline in the value of RMB assets held by Hong Kong residents may dampen household consumption.