Tuesday 2 December 2008
What’s Up with this RMB Depreciation?
It appears that the RMB is approaching a period of depreciation, and Beijing must be readying itself against what is surely to be a storm of protest from foreign (particularly US) markets and politicians. But it would be worthwhile to look into the reasons for the possible drop in RMB value. Is this a dark plot by the Chinese government to kick foreign economies when they are down, or what? A perusal of the facts might give some guidance.
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What’s Up with this RMB Depreciation?
Xu Yisheng, Beijing
2 December 2008
It appears that the RMB is approaching a period of depreciation, and Beijing must be readying itself against what is surely to be a storm of protest from foreign (particularly US) markets and politicians. But it would be worthwhile to look into the reasons for the possible drop in RMB value. Is this a dark plot by the Chinese government to kick foreign economies when they are down, or what? A perusal of the facts might give some guidance.
RMB depreciation signals can be found in the central parity rate, the trading price on the domestic market, and trends on the overseas NDF market. RMB’s central parity rate against USD on December 1 was 6.8505, a slump of 156 bps over the previous trading day. On the domestic spot exchange market, the RMB/USD rate dropped to the daily limit and closed at 6.8846. Meanwhile, the one-year RMB/USD price also declined to over 7.2, 2300 bps lower than the closing price last weekend.
We may think about RMB depreciation from three aspects.
First, a recent steep RMB interest cut has narrowed the interest gap between China and the US. The tax cut last week was the steepest since October 1997. After four interest cuts within two months, the one-year RMB deposit interest rate has fallen by 162 bps, narrowing the China/US interest gap from 214 bps to 152 bps, and expanding the RMB/Euro interest gap from 11bps to 73 bps. Since the RMB interest rate may see further cuts and the USD interest rate is near the bottom, in future the gap may be narrowed further. As room for arbitrage shrinks, international capital and hot money will have less interest in RMB, bringing pressure on the RMB exchange rate on the spot and forward markets.
Second, China’s economic slide is also putting downward pressure on RMB. The current crisis is the first real global financial crisis China has been a player in. Although worldwide economic recessions happened between 1980 and 1982, and from 1990 to 1992, China, with its low degree of participation in the world economy, was hardly affected. The ‘97-’98 East Asian financial meltdown was only a regional crisis and the US and European economy were not much affected, but it gave China its first real taste of financial problems beyond its borders. In 1997, though, China’s foreign trade dependence was only about 30%, and this number has risen now to 70%. The economic decline will certainly bring pressure to RMB exchange rate on spot and especially in the forwards market.
Third, it is unknown whether capital inflows will reverse and put depreciation pressure on the RMB. According to figures in September, the increase in foreign exchange reserve was much lower than the increase of normal foreign exchange reserve and trade surplus, showing that capital had begun to flow out. Due to the economic slide, interest rate cuts, and RMB depreciation expectations, foreign capital has lost its reason to stay or flow into China. The Chinese market has always worried that large foreign exchange outflow will put pressure to the Chinese economy and pull down the RMB rate. The low won (South Korean currency) rate is mainly led by withdrawal of foreign capitals.
Judging from these three aspects, RMB depreciation is led by the market, not the Chinese government. Another reason for RMB to depreciate is the current international situation. The 7.8% RMB appreciation since the beginning of 2008 has been the biggest among currencies of emerging markets. Its book exchange rate and actual exchange rate have soared by 13.4% and 13.5%, respectively. What is also worth mentioning is that RMB is the only currency of emerging markets that has maintained appreciation against USD. Statistics in October show the currency of Chile has depreciated about 20% against USD. Depreciation of all the currencies of India, Brazil, Philippines, Indonesia, and Mexico is greater than 15%. Major currencies of developed markets such the Pound Sterling, Australian Dollar, and Canadian Dollar have all depreciated drastically against the USD.
It should not surprise anybody that RMB is now set to join them. The heavy market pressure is not produced by the Chinese central bank. Or, we may say that the stable RMB rate in September was led by the manipulation of the central bank. However, that manipulation was not aimed at pulling the RMB rate down.
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