Wednesday 3 December 2008
RMB Depreciation Raises Worries Over Capital Outflow
China’s currency, the RMB, dropped to daily limit on both of the first two days, and touched the daily limit on third day, of December, to the surprise of the market, which is now in dispute over whether RMB, about the only currency that has maintained a strong position against USD in the second half of the year, is approaching a period of depreciation and whether depreciation will lead to large-scale capital outflow.
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RMB Depreciation Raises Worries Over Capital Outflow
3 December 2008
China’s currency, the RMB, dropped to daily limit on both of the first two days, and touched the daily limit on third day, of December, to the surprise of the market, which is now in dispute over whether RMB, about the only currency that has maintained a strong position against USD in the second half of the year, is approaching a period of depreciation and whether depreciation will lead to large-scale capital outflow.
The government, which over the past few years has fretted greatly over vast sums of inflowing “hot money,” has for the last several months been on the alert for capital outflow. In order to reinforce capital controls, the State Administration of Foreign Exchange (SAFE) and the State Administration of Taxation are jointly requiring overseas payments of qualified service trade, income, current transfer and some capital accounts over $30,000 to go with tax certification.
Detailed accounts include service trade income gained in China by overseas institutions or individuals, compensation gained by overseas individuals in China, income gained by overseas institutions or individuals such as dividends, bonus, profit, interest of direct debt, and sponsorship fee, rent, income from fixed asset transfer, and income from equity transfer gained by overseas institutions and individuals.
As risk of uncontrolled capital outflow is thought to be increasing, this measure helps to reinforce capital control. SAFE worries that various types of service trade may become channels of illegal capital inflow and outflow.
Should RMB depreciate?
Unlike the Ministry of Commerce, the National Development and Reform Commission, and the Ministry of Human Resources and Social Security, who tend to promote China’s export growth and employment via RMB depreciation, it is SAFE’s job to worry about large-scale capital outflow that RMB depreciation might trigger.
A supervisory department official told China Business News that steep currency depreciation might well trigger capital withdrawal, and that the negatives would outweigh the positives. Considering this, RMB must not be allowed to continue to slump.
Some analysts believe that RMB depreciation helps to promote export growth, but the official explained that the main problem facing the export industry is not price but weakened external demand. The exchange rate can have little or no effect when there is no demand.
No, probably not
There are some word changes in the central bank’s monetary policy report for the third quarter. Instead of emphasizing that the exchange reform should be “positive, gradual, and controllable,” it only declared it would “maintain a basically stable yuan rate, improve foreign exchange management, and keep gross balance.”
The official quoted above thinks this doesn’t mean RMB is approaching a depreciation period. “Continuous depreciation will trigger capital withdrawal and reinforce depreciation expectations. At the same time, more capital flowing out will worsen the depreciation.”
According to this official, the drop on Monday came from market expectations. On the one hand, the market is worried that the macroeconomic slide may accelerate, and on the other, as other major currencies have depreciated against USD, the market also expects RMB to decline.
USD has appreciated largely against major currencies, such as the Euro and Austrian Dollar, since July this year, while RMB/USD rate has remained quite stable, between 6.82 to 6.83. According to a Morgan Stanley report from late November, RMB’s book exchange rate and actual exchange rate have both risen by over 13% since the beginning of the year. RMB is the only currency among emerging markets to maintain appreciation against USD this year.
From July 2005, when China cancelled RMB’s peg with USD, the RMB rate has become more flexible. Since the trend of USD appreciation on the international foreign exchange market has been established, RMB can’t appreciate against USD alone.
Li Jun, foreign exchange analyst of FX168.com, thinks the RMB/USD rate will progress through three stages: fluctuation between July and November, followed by a depreciation period; then if both the Chinese and US economies rebound, RMB will continue its rise against USD.
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