By Hayden Briscoe
Many investors are worried about the future path of the Chinese currency after its sharp depreciation earlier this year. Based on fundamentals and the expectation that China will stick to its foreign-exchange policy, we think the currency has reached a fork in the road and is likely to rally.
The decision by the People’s Bank of China (PBC) early this year to weaken the renminbi (RMB) came as a shock to many investors who expected the currency to maintain a long-term path of appreciation. After all, the RMB had been strengthening against the US dollar for nine years, and its trajectory was consistent with the government’s stated aim of internationalising the currency.
For close observers, the move wasn’t unprecedented—or necessarily at odds with Chinese policy. The PBC made a similar move in mid-2012, lowering the rate at which the RMB was fixed daily against the US dollar. A six-month period of slight weakening followed; during that time, the PBC widened the RMB’s trading band against the rate fix. Eventually, the RMB resumed its upward climb.
This year’s episode appears to have followed a similar script. After moving to weaken the RMB after January by lowering the daily fix versus the US dollar, the PBC announced in mid-March that the trading band would widen from +/– 1% to +/– 2%. This guided weakening helped defuse market speculation that the RMB was a one-way bet, and the wider trading band, in our view, was in line with the policy aim of moving to a more market-driven exchange rate.
In the same way that the PBC’s actions don’t necessarily point to an end of the policy of managed RMB appreciation, the currency’s fundamentals don’t make a case for it being overvalued—or even fairly valued, in our opinion. China’s trade balance—the main driver of its balance of payments surplus—hit a record high of US$47bn in July and again in August at US$49bn. The country’s accumulated foreign-exchange reserves are about to top US$4trn, having risen by more than 500% since 2005; during that time, the RMB has appreciated by only 30% or so. This mismatch helps the PBC contain the risk of cheap money and credit bubbles in the domestic economy, but it also suggests the RMB is undervalued.
The expansion of China’s foreign-exchange reserves and balance-of-payments surpluses over time has put the country under pressure from the international community to strengthen the currency more quickly. China’s response has been to drive the RMB higher each year—in such a way that no depreciation is evident based on daily levels over any rolling 12-month period. Presumably, this is because it’s easier for China to engage with its international counterparts if it can honestly point out that currency policy is still on a path of appreciation at all times throughout the year.
In this context, we think the RMB’s depreciation so far this year is finite, and implies a likely recovery rather than further weakness. If investors believe (as the evidence suggests, in our view) that China hasn’t changed its stance on the currency, then the RMB’s performance should be flat to positive on a rolling 12-month daily basis.
If that’s the case, this year’s depreciation has reached a point relative to last year’s performance where the daily fix may strengthen and indeed reverse. This would enable the currency to resume its steady appreciation on a rolling 12-month daily basis and keep the positive currency policy intact.
In other words: the PBC’s policy desire to maintain an appreciating currency is likely to result in an end-of-year rally in the RMB, from our perspective.
Hayden Briscoe is director of Asia-Pacific fixed income at AllianceBernstein
Comments