The Renminbi will Remain Stable Despite Recent Fluctuations

Yifan Hu (PIIE)
March 4, 2014 10:15 AM

The  renminbi depreciated significantly in February. It fell a further 0.41% on February 28 following a 0.92% drop since February 17, making this the largest daily and monthly loss since the exchange rate reform in 2005. The renminbi depreciation was triggered by sell-offs caused by recent concerns on China's gloomy macro data, US QE tapering, and doubts about  China's trust funds and banking sector. The sell-off  was amplified by the forced liquidation of highly leveraged off-shore renminbi linked products under pressure.

For example, over $500 billion in HK is currently bet on renminbi appreciation via various derivatives without collateral, driving arbitrage between CNH and CNY up to 60-80 bp, and forcing some to sell off CNH during the large depreciation. Furthermore, billions of dollars in CNY-Yen carry trade also retreated once investors sensed depreciation. The CNY-Yen carry trade has become increasingly popular in recent years given the  4% annualized gains including 3% of interest spread and 1% of renminbi appreciation. This has created a surge of renminbi deposits in Hong Kong,  up to  1.01 trillion RMB by 2013 from 314.9 bn in 2010, backed by borrowing in Yen at a cost of 0-0.25%.

The PBOC has paid increasing attention to the one-way speculation occurring in the foreign exchange markets, particularly CNH-CNY arbitrage and CNH-Yen carry trades. Unlike other troubled emerging economies, the PBOC, still confident regarding the underlying strength of the renminbi, "allowed" significant depreciation during this period to break down one-way expectation of renminbi appreciation and thus punish currency speculators. After 10-days of  depreciation,  dual-way fluctuations has been confirmed, which will help control speculation, and paves the way for expanding the trading band and liberalizing exchange rates.

From a longer perspective, the renminbi exchange rates against the dollar will remain stable with slight appreciation for the coming 3 years mainly due to three factors:

1) China's strong fundamentals including fast growth (the fastest growing large economy regardless of whether it records 7% YoY or 8% YoY), high foreign exchange reserves ($3.8 trillion in 2013), a rising trade surplus ($259.8 billion in 2013) and robust FDI ($117.6 billion in 2013).

2) Rising demand  for renminbi trade settlement (4.63 trillionRMB in 2013), various CNH products in offshore markets (116.0 billion RMB in off-shore bonds in Hong Kong in 2013) and more currency swap contracts (2.8 trillion RMB in 2013).

3) China's determination to push the renminbi to become a world reserve currency in the coming years will lead to a de facto upward trend of RMB exchange rates over the long-term, despite short-term fluctuations.

Recent renminbi losses represent dual-way fluctuations rather than the start of a depreciation trend. The PBOC will likely  step in and intervene soon  as it is not in the best interest for the PBOC to allow one-way depreciation expectations to form. Concerns on the dollar loans of Chinese firms, including real estate companies, will therefore be short lived. The exchange rate against the dollar will remain more or less stable with gradual appreciation of the renminbi over the coming 3 years.


Chi Lo

Sir, I find it difficult to comprehend points 2) and 3) in your article for why they would underpin RMB appreciation. Point 3) makes political sense as no one would want to hold a depreciating RMB in the process of internationalisation. But economically, and together with point 2), RMB internationalisation should have a dperedciation bias on the RMB, ceteris paribus. This is because internationalising the RMB through trade means china will have to become a net goods & services importer and a net capital exporter (since this is the only way to send RMB offshore). RMB internationalisation and its exchange rate movement do not necessarily correlate with each other. To a certain extent, they are disjoint sets (esp. in the long run), in my view. Increasing usage of the RMB for trade settlement is a necessary condition for RMB internationalisaiton, but it may not have any effect on the RMB exchange rate. Cheers, Chi

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