China’s renminbi; how low can it go?

A key concern for global investors during 2015 – that China is keen to see the renminbi weaken against both the US dollar and other major currencies – has continued in the opening week of 2016.

The Financial Times and other business dailies report that the gap between the currency’s two exchange rates – the spread between China’s offshore market and more tightly controlled onshore market – has widened to a record.

This has renewed concerns that China’s authorities are relaxed about the RMB’s steady depreciation and could even encourage it to accelerate.

The management of the Chinese currency by the People’s Bank of China (PBoC) hit the headlines last August, when it unexpectedly allowed the RMB to depreciate by nearly 2% against the US dollar (USD) in a single day. The sudden devaluation was the biggest in two decades, unsettled international stock markets and reportedly persuaded the US Federal Reserve to hold off its long-awaited interest rate hike, which it had been planning to introduce in September, until just before Christmas.

Over the past five months the RMB has slipped further against the USD, reaching its lowest levels since 2011 in recent weeks. During this interim period, the PBoC’s campaign for the International Monetary Fund to give the currency reserve status was crowned with success in late November when the IMF agreed to include the RMB in its basket of reserve currencies with special drawing rights (SDR) from October 2016.

Last month the PBoC announced that the RMB’s exchange rate would be measured against a broader basket of currencies than previously. The new trade-weighted basket, in which the USD accounts for 26.4% of the RMB’s value and the euro (EU) 21.4%, was launched three weeks ago and the Chinese currency promptly moved lower against the greenback.

The PBoC acts to set a daily ‘fix’ for the RMB against the USD and other currencies and the onshore rate is permitted to trade up to 2% either side of that midpoint, while the offshore rate is free of such a restriction. This creates the spread between the two, which has widened over the past few weeks to suggest that investors anticipate further weakening in the Chinese currency.

According to the FT, the growing gap between the RMB’s onshore and offshore rates is an embarrassment for China as last August the PBoC promised to narrow it. The trend suggests that the RMB is failing to meet the IMF’s requirement of being “freely usable” and also that capital outflows from China are increasing in response to worsening economic conditions.

More importantly, it could revive investors’ fears that the pace of the RMB’s devaluation will accelerate in 2016, both undermining China’s economy and potentially setting off other competitive devaluation across Asia Pacific and other regions.

Paradoxically, the FT pointed out last month that the RMB’s close ties to the USD actually made it one of the world’s strongest performers against the surging greenback during 2015. As of mid-December it had fallen by 4.5% since the start of the year, while among China’s other major trading partners the South Korean won (KRW) had lost 7% against the USD, the EUR had fallen 10% and the Australian dollar (AUD) was down 12%.

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