Renminbi (RMB) watchers are reassessing their expectations of the currency. After years of the renminbi being a one-way appreciation bet against the US dollar the last few months have seen the currency suddenly reverse.
The shift in momentum first became noticeable last year when non-deliverable forwards (NDFs) stopped pricing in any significant appreciation of renminbi. This caused a slowdown in the dim sum bond market as investors suddenly realised that bonds from lowly rated Chinese corporates were not quite as attractive without the added upside of currency appreciation.
As of the middle of March, renminbi non-deliverable forwards, a type of derivative that predicts the valuation of currencies, were pricing in a depreciation of 0.2%.
This year has been even more traumatic for those that thought the renminbi could only move one way. Earlier this month a People’s Bank of China (PBoC) official said he thought the renminbi was reaching fair value level, which prompted a flurry of hand-ringing analysis about what this might mean.
Somewhat inevitably US Treasury secretary Timothy Geithner disagreed with this viewpoint. On March 20 he said China still had some way to go in getting its currency to a fairer market rate.
But worse-than-expected news about February’s trade data published on Mach 9 reinforced the idea that the renminbi path of appreciation might be coming to an end. China reported a trade deficit of US$31.5 billion, a figure that surprised economists on the downside.
This figure offered a counterbalance to predominantly American claims the artificially weak renminbi was responsible for the country’s trade surplus.
It has certainly not been all one way this year. The renminbi started 2012 at Rmb6.29 against the US dollar, falling to Rmb6.31 on January 10 and hitting the year’s low just before Chinese New year on January 23 at Rmb6.33.
It recovered a lot of ground in February return to the Rmb6.29 level during month. But March has been no fan to the renminbi bulls, with the currency slipping back to the Rmb6.33 mark following the recent disappointing trade figures.
China and everything piece of data connected with the country is scrutinised so closely for hidden meanings that often the market reaction bears little relation to the facts. A recent case in point was the sell in equity and commodity prices that followed Chinese premier Wen Jiabao’s announcement the country was targeting GDP growth of 7.5%.
The reaction really should not have been that extreme. China economists had expected the growth target to be less than double digits and it is widely expected that the country will comfortably overshoot that level.
The response to the recent currency fluctuations is equally as nonsensical. Yes the renminbi is more volatile than before, but in true Chinese style the authorities have been dropping hints they would allow it to trade more freely.
As recently as March 5, PBoC governor Zhou Xiaochuan said that conditions were ripe for the renminbi’s exchange rate to trade in a wider band.
Moreover, the Chinese authorities have signalled very strongly that they are putting the renminbi firmly on the path to internationalisation. A currency which moves and reacts to the market is a logical step and a necessary one.
Companies and individuals using the currency need to get used to a more free-floating renminbi so they can take steps to manage and hedge their exposure, in the same way they would with any other major currency.
Having signalled their intentions, China’s regulators now need to make sure the financial products are place that allows trading and business partners to hedge currency risk. This means the establishment of a functioning forwards options and futures market, ideally for the offshore as well as onshore market. Fluctuations in the currency are only positive when they are the tools in place to deal with them.
In the meantime, renminbi bulls can comfort themselves with fact that although the currency is experiencing more volatility China’s strong economic position should ensure that appreciation remains a safe bet, at least for now.