Beijing could opt to make the renminbi fully convertible in five years and lead Hong Kong to shift its currency peg from the US dollar to the mainland currency, predicts CLSA.
In a media conference call the Asia brokerage discussed the likely impact of an appreciating renminbi on China and broader Asian economies. While answering questions on this study Amar Gill, head of thematic research at CLSA said that he believed that the renminbi could become fully convertible in five years.
“In the last three to four years China has opened up its capital controls, there has been QDII [qualified domestic institutional investor scheme, allowing local investors to buy offshore assets] and more renminbi has been kept in Hong Kong,” he said.
“I think there will be more liberalisation and when the renminbi becomes a fully convertible currency, which might be in a five year timeframe, Hong Kong might consider moving to a renminbi peg instead of its US dollar peg.”
His confidence stems from a set of recent reforms over China’s currency and macroeconomic trends. Recent liberalisation over the renminbi includes the expansion of its offshore trade settlement scheme and allowing the currency to appreciate somewhat against the US dollar.
Such changes point to Beijing’s desire to move its economy away from a mercantilist model and towards a more consumer-driven one, especially when taken in conjunction with local reforms such as allowing provincial salaries to rise by around 20% to 50%. The combination of a rising renminbi and increasing local salaries would increase the purchasing power of locals, which in turn will lead to rising demand for local products and imports and help reduce China’s strong current account surplus.
It might also mean the relatively low loan to deposit ratio of banks would rise as more people borrowed money. This would be a healthy development for the country, Gill argued.
“If western consumers are not the engine economic growth for China [then growth] has to be driven domestically,” said Gill. “But if you push investments into infrastructure this places strain on the banks.
“The other part of economic growth is private consumption, which is just 36% [of China’s GDP]. That is one of the lowest levels in Asia while its savings rate [of 51% of GDP] is one of the highest, so consumer-driven growth can be sustained over the next five to 10 years.”
CLSA believes that that ultimately an appreciating renminbi will have an extremely positive impact on China’s economy.
“If China’s local economic growth is 9% a year on average this would mean that by 2014 on local currency terms its economy will be about 50% larger,” said Gill. “But if the renminbi also appreciates by about 6% a year, in US dollar terms this would mean the economy grows by 15% per annum and would mean that in five years it is double the size of today. The impact of appreciation is huge.”
He added that appreciation of 5%-7% a year is quite likely and manageable for the coming five years.
“Between 2005 and 2008 there was 21% appreciation of the renminbi while over the same period there was 141% rise in exports,” said Gill. “This reflects that there is enough flexibility to absorb 5%-7% appreciation [per annum] without any noticeable impact on the export figures.”
If the currency does appreciate by 5%-7% against the US dollar for continuous years it should reach Rmb5 to the US dollar in five to six years time. The last time China’s currency enjoyed a similar valuation against the greenback was in the early 1990s.
Allowing the renminbi to appreciate would also slow China’s rapid accumulation of foreign currency reserves. Gill notes that the People’s Bank of China has built up reserves of US$2.5 trillion compared to US$500 billion in 2004 as it bought US dollars to keep the value of the renminbi low.
It did this to give its exporters a cost advantage versus international rivals. But as the nation moves to encourage local consumerism it will not need to so assiduously defend its currency valuation. That means that the central bank will not buy as many US dollars, and China’s reserves will not grow as quickly.
This in turn is likely to lead to a rise in the yields of highly liquid benchmark bonds such as US Treasuries as Beijing’s need for them begins to drop, Gill said.
Gill believes that other Asian countries will also appreciate their currencies in tandem with China in the coming years. In large part this is due to rising concerns about inflation in the region.
“Allowing currencies to appreciate helps address imported inflation. We think that it’s more likely than not that central banks in the region will let their currencies rise and earlier this year we saw the Indian rupee, Malaysian ringgit and Indonesian rupiah make significant gains.
“As the renminbi appreciates we expect this will give other central bankers the confidence to appreciate against the dollar,” Gill said.
Other likely developments include the creation of a vibrant renminbi bond market in Hong Kong as more of the currency is used in the city, and a recalibration of commodities demand, with the demand for some materials such as metals dropping as infrastructure works are completed while others, such as oil and palm oil, gain in demand as consumerism rises.