The Change in Renminbi Expectations

Nicholas Borst (Federal Reserve Bank of San Francisco)



There has been a dramatic change in expectations around the renminbi’s exchange rate. No appreciation over the past nine months has meant the previously one-sided bet on steady appreciation is over. Accordingly, businesses are no longer as eager as before to hold renminbi.

Previously, corporations receiving payments in dollars were quick to exchange their earnings into renminbi in order to take advantage of the renminbi’s appreciation. This added to the demand for renminbi and forced to central bank to intervene to prevent the renminbi from appreciating by more than desired.

Sometime in the second half of last year appreciation began to slow and subsequently has on occasion dipped into outright depreciation.

Faced with this change in exchange rate dynamics, firms have altered their behavior. Instead of quickly changing their earnings into renminbi, businesses are holding on to their dollars. Businesses account for over 75 percent of total foreign currency deposits and most of the recent increase.

The reduction in demand for renminbi as a result of altered appreciation expectations has taken some pressure off the People’s Bank of China by reducing their need to intervene in the currency market and therefore slowing the accumulation of foreign reserves. Reserves were actually down 2 percent in the first half of this year.

The buildup of foreign currency deposits has also affected the balance of payments. China’s capital account (or, in the IMF’s terminology, the capital and financial account) is composed of direct investment, securities market investment, and a category called “other investment.” It’s in this “other” category that the change in foreign currency deposits is reflected. The accumulation of foreign currency deposits is a debit on the financial account and was significant enough drag the capital account down to $14.9 billion in the first half of the year, compared to $184 billion a year ago. The capital account even slipped into negative territory during the second quarter of this year.

Is this trend likely to change anytime soon? It’s hard to predict, but the market does not appear to think so. The market for non-deliverable forwards is pricing in little to no appreciation for the renminbi over the next year. Add the growth in foreign currency deposits, along with the decline in renminbi deposits in Hong Kong, to the list of indicators that perceptions around renminbi appreciation have significantly changed.

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