Two-Way RMB Fluctuation to Become the Norm
In the first half of the year, the renminbi exchange rate showed a depreciation tendency, which is a rare occurrence. At one point, it depreciated as much as 3.5 percent against the U.S. dollar. Yet, entering the second half, as the economy regains momentum, foreign trade surplus continues to climb and the margin of interest rates becomes increasingly attractive to international investors, this trend has come to an end.
Since policymakers are pushing forward the renminbi exchange-rate reform and its internationalization, its two-way fluctuations will inevitably become normal, which will pave the way for realizing the convertibility of the renminbi at the end of 2015 or 2016.
In fact, depreciation in the first half has much to do with the central bank's decision to expand the floating band of the renminbi exchange rate. Since the exchange-rate reform commenced in 2005, the renminbi has appreciated by more than 30 percent against the U.S. dollar. However, under the circumstance of the yuan appreciating in a unilateral manner, expanding its floating band may lead to further increase of its value, which will frustrate domestic export enterprises. This depreciation helped cement market expectations for two-way fluctuations and create a favorable environment for band expansion, allowing the central bank to enlarge the floating band of the renminbi's trading prices against the U.S. dollar from 1 percent to 2 percent.
Recently, with mini-stimulus measures and in-depth reforms being carried forward, China's economic prospects have dramatically improved. Export growth accelerated from 7.2 percent in June to 14.5 percent in July, far beyond market expectations and at the same time, import fell by 1.6 percent in July, which widened the trade surplus to a record high of $47.3 billion. Therefore, the depreciation trend is bound to reverse. The recent robust state of exports largely owes to the recovery of the overseas market, the implementation of policies designed to stabilize growth, and the initial depreciation at the start of the year. Given the buoyant state of trade and the economy as well as the high interest margins between the domestic and overseas markets, the depreciation in the value of the renminbi will probably grind to a halt.
However, even if the renminbi begins to increase in value in the second half of the year, the growth will likely be relatively moderate, and one-sided appreciation will not likely to occur again. It's predicted that the exchange rate of the renminbi against the U.S. dollar will float between 6.05 and 6.1. In short, the era of sharp appreciation of the yuan is now gone and will never return.
The first reason is China's receding advantage in labor cost. In recent years, labor shortages and rising wages have significantly jacked up production costs. Cheap labor will no longer be available to prop up China's exports. Some foreign companies have even moved their factories to Southeast Asian countries where labor is cheaper. In addition, stricter environmental protection standards and financing difficulties bring severe challenges to export companies. If the renminbi goes up substantially in the future, these exporters will be crushed.
Moreover, the international payments imbalance, often referred to as a "double surplus" in both current and capital accounts, has been remarkably improved. For instance, the proportion of current account against the GDP declined from roughly 10 percent in 2007 and 2008 to 5.2 percent in 2009, and then further to 2.1 percent in 2013. International experience shows that the range of 3-4 percent represents a reasonable and sustainable level. From this perspective, the current renminbi exchange rate is close to equilibrium.
Finally, China's outward direct investment (ODI) will experience robust expansion in the future, and is expected to surpass its foreign direct investment this year. The development bank founded by the BRICS countries has been headquartered in Shanghai, which will no doubt spur Chinese companies and banks to invest in emerging markets. Last year, the country's ODI totaled $90.17 billion, up 16.8 percent. This year, it's expected to surpass $100 billion.
Hence, the rate of the renminbi against the U.S. dollar should be kept between 6 and 6.3. In the future, the focus should be on building a more flexible mechanism to reduce one-sided appreciation or depreciation. China's policymakers have already quickened the pace of the renminbi exchange-rate reform and the internationalization process. Their efforts include promoting the independent pricing of the foreign exchange market and expanding the pilot reform of removing the upper limit of small foreign-currency deposit rates from within the Shanghai Free Trade Zone to the whole of Shanghai.
Meanwhile, China's central bank has been committed to realizing the liberalization of interest rates within the next two years. More countries have conducted currency swaps with China. Offshore renminbi products have diversified. All these indicate that China is pushing forward its renminbi internationalization process through the market-oriented reforms of exchange rate and interest rate, capital-account liberalization and the construction of the offshore market.
This is an edited excerpt from an article by Shen Jianguang, chief economist of Mizuho Securities Asia Ltd., published in Shanghai Securities News
China's fixed asset investment in the first seven months, a year-on-year increase of 17 percent
2.08 tln yuan
China's retail sales in July, a year-on-year increase of 12.2 percent
The year-on-year growth of China's industrial value-added output in July
Profit growth of leading Chinese Internet company Tencent in the first half of this year
12.48 tln yuan
The total assets entrusted to China's 68 trust management firms at the end of June, an increase of 14.4 percent from the beginning of the year
Profit decline of China Mobile, the world's largest mobile operator by subscribers, in the first half of this year
"Investment and consumption [in July] slowed from June but still kept in decent overall shape. Signs are apparent that the economy is stabilizing."
Li Huiyong, chief economist with Shenyin & Wanguo Securities
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