RMB trend and capital flows to display 'new normal'

October 10, 2015 08:05
The renminbi's exchange rate is on its way to stablilizing. Photo: Bloomberg

China is dedicated to opening up its financial markets as part of its efforts to promote the internationalization of the renminbi.

For the Chinese currency to be fully recognized internationally, the country must establish a real market-driven exchange rate mechanism with two-way flexibility.

We believe the People’s Bank of China considered three major factors when selecting Aug. 11 as the time to adjust the mid-price of the renminbi's trading band against the US dollar.

It was (1) before the International Monetary Fund made its decision whether to include the renminbi in the currency basket for its Special Drawing Rights; (2) before the US Federal Reserve's potential rate hike in mid-September; (3) in the time window when China’s increasing trade surplus in recent quarters (due to price cuts in imported commodities) could hedge the potential impact of money outflows.

Has the depreciation of the renminbi helped to increase China’s competitiveness in trade?

So far, no.

Although the currency has depreciated by about 3 percent against the greenback, exchange rates with other major trading partners’ currencies remain stable.

We believe that a cap on further appreciation of the renminbi is an ideal side effect of the PBoC’s move but was not a major consideration when the regulators made their decision.

The exchange rate has bounced back by about 1 percent, possibly reflecting the influence of PBoC’s stabilizing measures.

Investors will need more time to get used to the volatility and shake off the old mindset that the renminbi would just continue rising.

The use of foreign reserves is necessary to stabilize the market and exchange rate.

We think the Chinese government has full control over the market and the situation is not as threatening as some market players think.

As China’s trade surplus undergoes a structural shrinking, more outbound investment by domestic firms and a larger demand for overseas asset allocation from Chinese families, China will face a “new normal” of two-way money flows.

The large amount, nearly US$4 trillion, accumulated in China’s foreign reserves is neither normal nor sustainable.

As Chinese enterprises rush to refinance their US-dollar-denominated debts and arbitrage positions are unwound, capital outflows from China will shrink in the coming two or three quarters -- which means the renminbi exchange rate will stabilize in the short term.

In the medium term, there will still be room for the renminbi to depreciate if necessary.

But the process will be long and gradual.

When the rate stabilizes and two-way flexibility is realized, the trading band of the renminbi against the US dollar can be further expanded.

This article appeared in the Hong Kong Economic Journal on Oct. 9.

Translation by Myssie You

[Chinese version中文版]

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Head of China equities, BlackRock, Inc.