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Guest Commentary: Renminbi Has Hit A 19-Year High, But Can Go Higher - Coutts
Tom Burroughes
14 May 2013
The Chinese yuan – or renminbi
– has risen sharply in recent weeks, and the Central Bank of China has pegged the currency at
6.19 to the dollar, the highest level in 19 years. The authorities of the world’s
second-biggest economy allow the yuan to trade by one percentage point in both
directions against the greenback and economists and others continue to
speculate when, or whether, the currency will freely float. Brian Jackson,
global foreign exchange strategist at Coutts, looks at the prospects for
further yuan gains. As ever, the views expressed in this article are those of
the author and not necessarily shared by this publication. The Chinese yuan has risen sharply in recent weeks,
prompting officials to take steps to limit speculative activity. We
nevertheless believe the case for further yuan appreciation remains intact -
though officials are likely to try to moderate the pace. Although domestic economic data have been mixed, yuan
sentiment has been buoyed by signs that Beijing
is seeking to boost the flexibility and international use of the currency. The
yuan is a tightly-controlled currency and Chinese authorities limit daily moves
in its exchange rate versus the US dollar to no more than 1 per cent.
Officials, however, have hinted that this range may be widened in coming
months, providing greater scope for appreciation. Providing further support to the currency was news that the Hong Kong authorities are relaxing local rules relating
to yuan capital flows. And in mid April, the Reserve Bank of Australia
announced plans to allocate around 5 per cent of its foreign reserves to
yuan-denominated assets, representing a significant vote of confidence in the
yuan as a potential reserve currency. These developments have clearly provided much of the impetus
for the gains posted by the yuan in recent weeks. However, this acceleration is
likely to have been regarded with some caution by Chinese policymakers, who
have shown in recent years a preference for exchange rate reform to progress at
a gradual and steady pace. Officials have also been keen to avoid giving the
impression that yuan appreciation is a “one-way bet” - a suggestion that would
encourage speculative activity and attract “hot money” inflows into Chinese
financial markets, providing further impetus to yuan gains. The prospect of quick yuan appreciation can also distort
incentives for Chinese banks and companies. Recent data showing a sharp pick-up
of foreign currency lending in the Chinese banking system suggests that banks
are lending and firms are borrowing foreign currency based on expectations that
a stronger yuan will yield them a quick profit, rather than for
business-related uses, such as to fund foreign investments or provide trade
finance. This type of activity is always frowned upon by Chinese
authorities. Over the weekend, the State Administration of Foreign Exchange,
the agency responsible for regulating the Chinese foreign exchange market,
announced that it would tighten rules to limit the size of banks’ foreign
currency loans relative to the size of their foreign currency deposits. Some estimates have the foreign currency loans-to-deposits
ratio in the Chinese banking system as high as 170 per cent. However, SAFE is
tightening scrutiny and enforcement, with the aim of bringing this figure down
to 75 per cent for Chinese banks and 100 per cent for foreign banks. Officials
will also be doing more to make sure that companies’ demand for foreign
currency is based on trade flows and business-related purposes rather than
driven by speculation on yuan appreciation. Full convertibility Although SAFE’s announcement over the weekend prompted some
yuan weakness early this week, we do not consider this a sign that the trend of
yuan appreciation is set to reverse. Longer-term policy objectives by Chinese
officials - including the need to boost domestic consumption and reduce China’s
dependence on external demand as a source of economic growth - continue to
point towards the need for a stronger currency in coming years. Beijing
is also proceeding with its plans to enhance the status of the yuan as an
international currency. Efforts are aimed at increasing its use in global trade
and investment flows and taking the necessary steps for other countries to
accept the yuan as part of their foreign reserves. An important requirement to
achieve this objective is to make the yuan fully convertible. Earlier this week
(coinciding with the efforts designed to curb speculative activity), the top
decision-making body of the Chinese government, the State Council, announced
that it had instructed officials to draw up plans to make the yuan fully
convertible in the capital account. This suggests that portfolio investment and borrowing will
be liberalised significantly in the next few years, with fewer restrictions on
foreigners investing in Chinese markets and Chinese residents investing in
foreign markets. Gradual pace These longer-term objectives of Chinese authorities suggest
the case for further yuan appreciation remains intact – in line with our
forecast for the dollar/yuan exchange rate to trend lower over the next 12
months. Although the recent acceleration in yuan appreciation has
taken this currency pair beyond our near-term forecasts, the events of the last
few days highlight the risk that there could be some near-term interruptions to
the longer-term trend as officials try to prevent yuan gains from happening at
too fast a pace. Nevertheless, we continue to forecast dollar/yuan to fall in
coming months, with risks increasingly skewed to the downside for our forecast
of 6.10 at the end of the first quarter of 2014.