24 October 2016
The devaluation will help stimulate China’s economic growth, which in turn will eventually restore market confidence in renminbi assets. Photo: Xinhua
The devaluation will help stimulate China’s economic growth, which in turn will eventually restore market confidence in renminbi assets. Photo: Xinhua

Why renminbi devaluation is a one-off move

From an economic viewpoint, the renminbi will be excessively strong if it appreciates along with the US dollar.

Such an appreciation will deviate from China’s economic slowdown and cause more damage to the nation’s economic restructuring.

From my point of view, it is a must for the Chinese currency to be devalued against the US dollar.

First, the yuan devaluation has created more room for monetary policy. The surprising fall in China’s export growth in July was partly due to the strong Chinese currency, apart from weak external demand.

As a result, the Chinese central bank had to slash the interest rate and the reserve requirement ratio for banks in a bid to cap the real interest rate rally.

Proper devaluation of the renminbi will alleviate the pressure on monetary policy.

Second, the move will also benefit China’s move to liberalize it capital accounts. The market reform is a key part of China’s efforts to make the yuan a global currency and allow it to join the International Monetary Fund’s special drawing rights (SDR) basket.

However, global investors may stay away from renminbi assets for fear of devaluation if the exchange rate has completely deviated from economic fundamentals.

Some foreign politicians have accused Beijing of meddling with the exchange rate. However, China has in fact kicked off the market reform of its exchange rate regime by allowing the currency to move closer to the market rate.

If not, persistent fears of a yuan devaluation will affect the offshore renminbi market. For example, the CNH interest rate has been steadily higher than that in the onshore market, reflecting tight liquidity in the offshore renminbi market.

Beijing’s yuan devaluation has mitigated market expectations for a long-term depreciation, although there might be some volatility in the short and medium term.

It’s a tough decision, which would cause losses for investors, but it has allowed investors see the future direction of the redback.

Also, it would help stimulate China’s economic growth, which in turn would eventually restore market confidence in renminbi assets.

Global investors would invest in the yuan and yuan-denominated assets if they believe the currency won’t continue to devalue in the long run.

Third, the yuan devaluation will help Beijing gain a bigger say in its foreign exchange policy, even while the United States is on track to hike interest rates in September. The move has offset any massive capital outflow pressure in the future.

The one-time devaluation has helped establish a new range for the renminbi’s exchange rate within a period, allowing Beijing to have a bigger say in its foreign exchange policy. It would avoid a double hit from the impact of a US rate hike on its currency and capital outflow.

And the Chinese central bank still has more than four months to optimize the exchange rate regime and capital accounts liberalization, which would help its fight for including yuan into the SDR basket.

In theory, I believe the central government hopes to adopt a one-off devaluation strategy rather than a gradual depreciation tact. The latter would trigger arbitrage and increase costs for Beijing to manage its foreign exchange rate.

If the Chinese central bank manages to stabilize the exchange rate in the near future, and restores market confidence, the country’s foreign exchange reserve will start to pick up again.

However, the foreign exchange market is set to witness huge volatility in the following days as global speculators take advantage of the opportunity to short-sell.

No central bank would say its currency will continue to devalue, which would lure global investors to attack its currency.

There is no basis for the continued depreciation of the redback from the international and internal economic situation.

China has managed to maintain a 7 percent growth rate in the first half of this year despite internal and external challenges.

The sharp changes in the money supply and bank loans for July are temporary and manageable.

Beijing will continue to stick to a prudent monetary policy.

Meanwhile, recent economic data is encouraging, pointing to positive signs in economic development. That has laid a solid foundation for a stable exchange rate.

Also, China’s current accounts surplus has reached US$305.2 billion in the first seven months of this year. This is critical to the supply and demand fundamentals in the foreign exchange market.

Beijing has accelerated its reforms to internationalize the renminbi and open up its financial markets. Foreign investors have increased demand for the Chinese currency in trading, investment and asset allocation. That has injected a fresh momentum for a steady renminbi.

The market has long priced in the impact of a stronger US dollar following a US interest rate hike. The market is set to stabilize after a short-term reaction to the rate increase.

In addition, China has ample foreign exchange reserves, a healthy fiscal situation and prudent financial systems, which all support a stable foreign exchange rate.

China has adopted a market-based and managed floating exchange rate regime, and as such, investors should treat the exchange rate volatility sensibly.

The central bank will let the market gain a stronger voice in the pricing of its currency, and this will further stabilize the exchange rate and allow it to reach a new equilibrium.

This article appeared in the Hong Kong Economic Journal on Aug 17.

Translation by Julie Zhu

[Chinese version中文版]

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Senior investment banker

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