Qu Hongbin, co-head of Asian economics research
There are two stories to the renminbi: one revolves around its pace of appreciation against dollar, the other around its internationalisation. The first will be a relatively boring story, but the second will be a fundamental game changer for global markets.
We expect the renminbi to continue appreciating against the dollar in the second half of this year, but the pace will be slow at around 3%-5% per annum.
We see no need for Beijing to rely on appreciation to check inflation. It's quantitative tightening has been working, slowing credit growth to around 17%yoy from over 20% six months ago. Tighter credit conditions have been cooling aggregate demand too, as illustrated by the slow down in recent PMI survey numbers. All of which means that inflation should peter out in the coming months – without any fundamental change to China’s currency policy.
Moreover, with China’s trade surplus continuing to narrow (as it has been since 2007, and currently stands at 3% of GDP), balance of payment pressures are in decline. This points to more gradual renminbi appreciation in the future.
For the near-term, the People’s Bank of China (PBoC) will likely step up efforts to increase the flexibility of renminbi, implying more fluctuation against the US dollar and other currencies on a daily basis, or even brief periods of marginal depreciation. This should help reverse appreciation expectation and dampen the speculative inflows.
For the longer-term, the internationalisation of the renminbi is taking off. Since 2009, the progress has been and will likely continue to be faster than many expect. We anticipate that a third of China's trade will likely be settled in renminbi within three years, making it one of the top three currencies within global trade.
The process is triggering a chain reaction of reforms within the domestic financial market, and will likely result in an earlier-than-expected liberalisation of China’s capital account and full convertibility of the renminbi.
Full convertibility of the renminbi will pose a challenge for Beijing’s management of its foreign exchange risks. The market will ultimately decide where the renminbi’s fair value should sit.
Stephen Green, regional head of Greater China research
Robert Minikin, senior foreign exchange strategist,
We like a contrarian call as much as the next man. But calling the renminbi a sell is not one of our favorites.
The first version of the ‘sell renminbi’ trade is a crisis call. China is a huge bubble, the argument goes, and when that bursts, the government will do all it can to restore growth, including devaluing the currency.
We find this to be a highly unlikely scenario. China’s economy is slowing because the authorities in Beijing have tightened credit. Once inflation is beaten, credit controls can be eased and after a slower third quarter the economy will pick up steam from the fourth quarter of 2011 to the fourth quarter of 2012. The fundamentals of the economy are sound.
Moreover, if China did experience a hard landing, the authorities would re-peg, they would not devalue. A domestic slowdown would hit imports, and thus push the trade surplus up, not down. Beijing would throw its energy into other measures to support growth, like starting more infrastructure projects or increasing exporters’ VAT rebates. Sell the Australian dollar or H-shares or copper if you think its hard-landing time, not the renminbi.
The second version of the ‘sell renminbi’ trade is that China has had so much inflation that its ‘real’ exchange rate, or the price of its exports compared to others’ exports, has already adjusted up. Of course, cost pressures have increased. Manufacturing wages rose by some 10-15% in nominal terms this year.
But China’s manufacturing exports continue to build market share. China may well lose clothes and shoes to South-east Asia, but in mid-tech and hi-tech it is still far more competitive. As a result, despite all the oil, iron ore and soy we import, we still have a sizeable trade surplus. And as productivity growth grows faster in China than in most of its trading partners, expect gradual appreciation to be the medium-term story too.
The renminbi has gained by 5.5% against the US dollar over the past year but markets currently discount just 1% over the coming year. Investors should consider adding exposure to renminbi-denominated assets at these levels, we believe, rather than squandering premium on ‘cheap’ yuan downside bets. The rapidly growing offshore renminbi market in Hong Kong offers offshore investors new opportunities to do just that.
Patrick Perret-Green, head of Asia foreign exchange and local markets strategy
“Despite extensive efforts on the part of analysts, to my knowledge, no model projecting directional movements in exchange rates is significantly superior to tossing a coin. I am aware of the thousands who try, some are quite successful. So are winners of coin-tossing contests.” – Alan Greenspan
While many would dispute Greenspan’s comments, particularly those of us employed in the forecasting profession, it highlights the difficulties in dealing with such questions. Moreover even if a currency is fairly valued, as Greenspan implied, it can still move sharply in price from some theoretical ideal.
A US politician would tell you that the renminbi is definitely undervalued. A mainland China manufacturer with profit margins in the single digits would say the opposite. A Shenzhen resident buying his groceries in Hong Kong would concur with the latter, but express his happiness.
Looking at real effective exchange rates published by the Bank for International Settlements the numbers do not suggest that the renminbi is undervalued to any great extent. Moreover increasingly in bilateral talks between China and the US there is a much greater recognition about the validity of Chinese arguments about real effective rates thanks to the renewed appreciation of the renminbi and much higher Chinese inflation.
The steady reduction in the trade surplus as a percentage of GDP also indicates that progress has been made in the rebalancing programme and imports are increasingly competitive.
Our central projection is that China will continue with its deliberate policy steady appreciation of roughly 5% per annum against the US dollar. This helps combat inflation and forces Chinese companies to improve productivity and move up the value chain as Germany has done.
However, this policy is not without risks. If productivity fails to be maintained China could find itself increasingly uncompetitive. But while some production may shift to other countries few, if any, have the scale or ability to make a significant impact on China’s market share.
For now we do not believe that the renminbi faces any danger of becoming overvalued in the next couple of years. However, looking further ahead it is hard to assert that the risk of becoming overvalued does not exist.