Dollar rally puts focus on Beijing
China’s currency has long been hitched to someone else’s wagon – that being the US dollar. But as central banks across the developed world plot diverging courses, Beijing is fast finding that the renminbi is prone to travel sickness.
Some analysts warn that the current slide in the yen and the euro is raising pressure on China to boost competitiveness by weakening the renminbi, something that would send shockwaves across the global economy.
China’s currency is anchored to the US dollar, against which it can rise or fall by a maximum of 2 per cent a day from a fixed rate set by the People’s Bank of China. This mechanism gives the central bank effective control of the exchange rate against the dollar, but not against the currencies of its other major trading partners.
While the renminbi has fallen this year by around 1 per cent against the dollar, it has risen recently to a record high against the Japanese currency, and is at its strongest against the euro for more than a decade.
On a trade-weighted basis, the renminbi has risen more than 15 per cent since the start of 2013, according to an index compiled by JPMorgan. Excluding Hong Kong, the eurozone is China’s largest trading partner while Japan is number three.
Though not a widely held view, Lombard Street Research estimates that the renminbi is now 15-25 per cent overvalued, and will depreciate as China looks to shift its economic model away from fixed-asset investment.
In the meantime, increasing exports to boost growth is the “only palliative” for the country’s economic malaise, Lombard’s Charles Dumas wrote in a recent report.
China’s currency management system has left it vulnerable to fluctuations caused by recent changes to central bank policy in the US, Europe and Japan.
Last week the Bank of Japan announced a major ramping-up of its asset buying scheme, less than two days after the US Federal Reserve ended its own quantitative easing programme. The result has been a steep drop in the yen, which hit a seven-year low of Y114 against the dollar earlier this week.
The yen and the euro have appeared locked in a race to the bottom, with each dropping 10 per cent against the dollar in the past six months. Against the renminbi, those declines are even greater, with each losing 12 per cent.
Meanwhile, the Chinese economy has continued to slow, recording its lowest growth since the financial crisis in the most recent quarter. Though exports picked up in September, wrinkles in the data suggest the numbers have been inflated by fake invoicing – an old ruse used to sidestep China’s capital controls.
There is also the possibility of lower interest rates in China to help boost domestic demand. Barclays economist Jian Chang forecasts two rate cuts – one by the end this year, and another in the first quarter of 2015.
However, many analysts believe the most likely course is for the renminbi to be held steady against the dollar, rather than for a significant devaluation. Sacha Tihanyi, FX strategist at Scotia Bank, says stability is more important than the exchange rate in achieving China’s goal of economic transition.
“The last thing you want to do is disrupt financial markets and prompt capital outflows, which is what a policy of devaluation would do,” says Mr Tihanyi. “It wouldn’t be consistent with China’s policy preference.”
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