16 September 2019
Many factors could combine to weigh on the value of the renminbi. Photo: Bloomberg
Many factors could combine to weigh on the value of the renminbi. Photo: Bloomberg

Renminbi faces pressure despite expected inclusion in SDR basket

The offshore renminbi weakened by as much as 4 percent following the one-off reform of the daily fixing that the Chinese central bank carried out Aug. 11.

However, the Chinese currency has recouped half of its loss since September, with the gap between onshore and offshore markets narrowing.

That indicates foreign investors are less bearish on the redback.

The renminbi has stabilized over the last two months or so as a result of various factors.

Investors expect the currency to be included in the International Monetary Fund’s basket of currencies for its special drawing rights (SDR) next month.

The People’s Bank of China has been actively intervening in the market to defend the redback.

And the unwinding of short positions also supported the currency.

The IMF will decide whether to include the Chinese currency in the SDR basket soon, and it’s widely expected that it will give the green light.

In fact, many financial institutions estimate the chances of its doing so to be 80-90 percent.

The problem is whether the inclusion will be approved subject to certain conditions, Goldman Sachs said.

Meanwhile, the yields of China’s government bonds are the highest among those of the countries that have currencies in the SDR basket.

The US dollar, euro, pound and Japanese yen account for 90 percent of the SDR basket.

Long-term demand for the renminbi is quite robust after considering the potential return and risk diversification.

The renminbi might account for 7-10.5 percent of global reserve assets within six years, given an initial weighting of 10-15 percent in the basket, Société Générale estimated.

That is equivalent to US$540 billion-US$810 billion.

Nevertheless, Beijing has yet to fully liberalize its capital account, and the liquidity and depth of the market for offshore renminbi bonds and offshore yuan-denominated government bonds need further development.

The offshore renminbi bond market is 560 billion yuan in size, and the offshore yuan-denominated government bond market has reached 86.4 billion yuan.

Their onshore counterparts are 33 trillion yuan and 9.8 trillion yuan in size, respectively, Bloomberg figures show.

So, the offshore markets represent only 1.7 percent and 0.88 percent of the respective onshore markets.

It remains questionable whether investors will rush to increase their renminbi assets as a result of the SDR inclusion, which in turn may drive up the currency.

Investors and central banks will take into account liquidity, free convertibility and effective market operation as key factors when considering investment in a certain currency or asset.

Also, the Chinese currency still faces downward pressure in the short and medium term from a macro perspective.

The Chinese central bank will continue its monetary easing measures to stem an economic slide or even launch a Chinese version of quantitative easing.

The increased supply of credit is set to weigh on the currency.

Sluggish economic growth will also accelerate capital outflows, exerting pressure on the currency.

Meanwhile, the US Federal Reserve is taking the opposite path, hinting at an imminent tightening cycle.

The central banks of Europe and Japan intend to ramp up monetary easing.

That would lead to further US dollar strength and exert more pressure on the redback.

The strong US dollar has driven commodity prices into a slump and lured capital out of emerging markets like China.

The excessively strong renminbi faces mounting pressure.

The Bank of International Settlements effective exchange rate shows that the Chinese currency has already appreciated by as much as 31 percent since the second quarter of 2011, which means it is valued at 30 percent above the currencies of other emerging economies.

This article appeared in the Hong Kong Economic Journal on Nov. 6.
Translation by Julie Zhu

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Hong Kong Economic Journal chief economist and strategist