This is in agreement with my earlier "speculation" that RMB will appreciate at a rate of around (not more than) 2.5% p.a. on average, at random timing, based on the need to discourage speculative activities.
However, one should also note that 2-3% is the typical premium any investment bank (MS, CSFB, GS) would charge for hedging, for a 12 month contract. What this means is that the 1% p.a. option premium SAFE charges the bank is ridiculously cheap, because the duration of this option is 3% for 36-48 months (Xie said it was 1% p.a.). We know the risk is much higher if the duration for an option is longer.
According to Xie Ping (via Talk Talk China), the options were signed in Jan/5/2005, Jan/12/2005and Apr/20/2005 for BOC, CCB, ICBC respectively, for an amount of $18bn,$22.5bn and $12bn. Another point to note is from the original text of Xie Ping in Chinese, he offered to interpret that "the risk is shared between SAFE and the banks" means that they are merely following what an option underwriter would do. It does not neccessarily mean that they share the cost mathematically, as TalkTalk has interpreted. (是商业银行和汇金公司用市场化方式共同承担了风险。商业银行支付了期权费，我们执行约定的买入价格。这是期权交易，其他投资者既然关心这个问题，我们就用市场化的方式解决掉这个问题。汇金公司这么做是很市场化的，投资者看到资本金汇率风险已经对冲，就不用担心此事了。) In fact, Xie alleged that SAFE has hedged the risk in the market already, although I do not understand how it did that, maybe through issuing RMB bonds?
Another minor point worth mentioning is that the strike price is RMB8.277/USD for these options. Therefore, whatever TalkTalk predicts, we need to subtract 2.1% from his number because the rate today is already around 8.11. i.e. SAFE's gross profit is 0.9% only today, assuming RMB does not depreciate or appreciate further, and neglecting interests earned/lost from the premium and hedging operations.
There are two possible ways to interpret this
- SAFE is pricing the option at a huge discount, in a way subsidizing the banks
- SAFE did not expect major changes, or as TalkTalkChina reasoned, the range will not be much larger than 6% (from 8.277)
Another way to look at this, is to plug the premium of 1% p.a. (more accurately 3% for 3 years)into Black-Scholes and calculate the implied volatilities. I do not know how much the NDF underwriters are charging now (was reported to be around 3% p.a. before July 21), but the implied volatitily they use must be a lot higher than that used by SAFE. (Black Scholes theory shows that the higher the premium, the higher the implied volatility, which is a measure for the expected fluctuation of the strike price) If SAFE is acting rationally, or it knows something we do not know, the NDF underwriters are making obscene profit. In other words, RMB will appreciate at a rate much slower than NDF market expectation, or SAFE is going to lose a lot of money. My "epiphany"? let's go into the NDF underwriting business.
(also note: this may, in part, explain why the reval on July 21st was adjusted from pbc proposed (reportedly)5% to 2.1%, as SAFE might have joined force with Ministry of Commerce, unless they did hedge it by issuing RMB bonds)