Saturday, April 19, 2014
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Renminbi Rising

BEIJING – On October 26, the renminbi’s spot exchange rate against the US dollar reached the upper limit of its floating range for the second consecutive trading day. The rise began when the trading band for the renminbi’s dollar exchange rate was widened to ±1%, and has now reached an all-time high since 1994’s currency reform. With little sign of improved economic fundamentals, rapid currency appreciation is a potentially dangerous development for China – in part owing to the risk of an abrupt and painful reversal.

The renminbi’s rise over the past month can be attributed to greater global liquidity since the start of the third quarter, as policymakers have responded to the eurozone’s sovereign-debt crisis and stagnating output. Indeed, according to Morgan Stanley, monetary authorities in 16 of the 33 countries that it follows – including seven of ten advanced-country central banks and nine of 23 central banks in emerging markets – have either cut their benchmark interest rate or lowered reserve requirements.

After two rounds of quantitative easing (QE), the balance sheets of the European Central Bank and the United States Federal Reserve have grown to €3.2 trillion ($4.1 trillion) and $2.9 trillion, respectively. The ECB’s new outright monetary transactions (OMT) program in secondary sovereign-bond markets, and the Fed’s open-ended “QE3” continue this trend, while the Bank of Japan has expanded its asset-purchase program for the eighth time.

The spillover from the developed countries’ latest round of QE is beginning to show up in emerging markets, where nearly a year of short-term capital outflows has given way to a new wave of short-term inflows. With US domestic bond yields continuing to fall and US equities reaching an upper price limit, owing to the real economy’s sluggish recovery, more money is expected to flow to commodity markets and higher-yielding emerging countries. Given China’s adherence to a stable monetary policy, the renminbi has become a more attractive asset to hold.

Indeed, as the renminbi strengthened over the last month, the People’s Bank of China did not intervene strongly to repurchase dollars from commercial banks – a decision rarely seen in recent years. This indicates that the renminbi’s appreciation was driven mainly by short-term arbitrage by outside funds.

Another reason for the appreciation is the renminbi’s peg to the dollar, which has fluctuated increasingly widely since October 2011. As a result, while the renminbi performed poorly against the dollar in the first half of this year (even depreciating temporarily), America’s year-end “fiscal cliff,” together with QE3, has weakened the dollar since the start of the third quarter, with the exchange rate falling back to its level at the start of this year.

But there is still a need to be vigilant. While the onshore and offshore renminbi markets remain decoupled, the start of renminbi settlement under the trade account enables Hong Kong’s offshore renminbi (CNH) currency market to coexist with the onshore (CNY) market, leaving significant room for arbitrage. Given that the renminbi’s real and expected rates of return are higher than the real rate of return of other currencies, it has become a positive carry against foreign currencies, reinforcing the tendency to hold assets in renminbi and liabilities in foreign currencies.

Because China is still enforcing capital controls, it is not easy for foreign investors to put their money into the CNY market. Therefore, most short-term foreign inflows have detoured through the CNH market. Indeed, the Hong Kong Monetary Authority has had to inject liquidity into its banking system four times in recent months – more than HK$14.4 billion – to stabilize the Hong Kong dollar’s exchange rate, which clearly indicates that the international hot money flowing in is actually heading to the mainland.

Even with its recent strengthening, the renminbi is within a balanced exchange-rate band that is appropriate to its foreign-trade balance; still, China’s economy could not bear sharp exchange-rate appreciation. Fortunately, that seems unlikely. In fact, both the deliverable and non-deliverable forward rates anticipate one-year renminbi depreciation of 2.35% and 1.75%, respectively.

In fact, the renminbi could be shorted again – most likely via the CNH renminbi market. In early December 2008, the worldwide crisis led to a global capital outflow from China, and the exchange rate of the renminbi fell to its lowest limit four days in a row – a record since the exchange-rate reform of July 2005. Then, beginning on November 30, 2011, the exchange rate approached the bottom of the trading band for seven days, causing panic in the market. These events are not distant memories.

After all, a currency’s exchange rate is not determined only by economic fundamentals. There will always be foreign short-term flows that can increase a currency’s volatility. Indeed, after its recent sharp appreciation, the renminbi could turn out to be a prime target for short sellers.

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  1. CommentedJonathan Lam

    Gamesmith94134: Renminbi Rising

    “With little sign of improved economic fundamentals, rapid currency appreciation is a potentially dangerous development for China – in part owing to the risk of an abrupt and painful reversal.”

    In the recent discussion on sovereignty environment risk, I thought the digital balance act on trade and international business may not be sufficient; and we should have emphasize on the moral restrains on how we undercut sovereignty environment risk. Apparently, Renminbi CNY and Hong Kong yuan CNH are haunted by their surpluses and growth; the bombardment on the inflow of hot cash that ignited another currency war. On the other hand, DJ lost 200 on a day that showed outflow made a halt after the Hong Kong Central Bank interfered the transaction the fourth time or someone is clearing his draw for US dollars for the CNH or CNY sold. I hope they are not related but my theory someone attempt to tilt the balance of exchange rate; and I takes its stand of the silver lining on how the currency is appreciated or what makes the world goes around.

    Dollar performed badly in the last couple days, and the internal market in Hong Kong and China is charging the risk of hyperinflation on its imports and negativity of credit crunch on the commercials; if the dollar and renminbi are being manipulated to its exchange rate to yield profitability. If both are embarrassed for the fear of their rapid change rates by enforcing more of governmental or Central Bank interference; I supposed they should compromise on the surpluses and hot cash in the future talks.

    Perhaps, they should not fight over the exchange rate for sake of the profitability or investment from governments, these funds must be detected and control through the IMF and the transfer unions. Many blame on the international Banking and its monitors on credits and exchange rates; I hope both should take another alternative on utilities on the world banking system that oversees these sovereignty funds and debts; instead, both are getting emotional on how to balance the trade to zero sums in a day; or just focus on the exchange rate or interest rate that are variables. There must be a transitory control on sovereignty debt or funds; and each must open its markets on the credit or burdens that foreigner’s investment injected to its economy instead of making restrictions on trade.

    For much of the third in the throw weight system that have less influence on the exchange rate , I think it is time China should work more on the weight on the exchange rate that they should give up its surplus to cut the expenses on the loans to the debtor nations; and The FED should know well how its 4 trillion accountable on book may come to haunt them as well if inflation returns prior 2015, or credit crunch arrives by the outflow of how other deleverage its exchange rate if it falls. I do not think there is another alternative if both buttress on the war of its exchange rates.

    For sake of your next generation, real estate or commodity price is not a trade off, and they have adverse effects on your sons and daughters. Money does not grow on the tree of exchange rates. Growth comes from the value after equitable and employment if deflationary is not appropriate.

    Can they make it?

    May the Buddha bless you?

  2. CommentedFrank O'Callaghan

    The renminbi is set to appreciate. This is inevitable with the trade surplus. Only currency manipulation prevented it. It has great negative consequences for China unless it can develop it's own internal market. Unemployment and poverty will destabilize.