A new regime for the renminbi
After so much speculation, China announced a new exchange rate regime on 21 July for the Chinese currency, the renminbi, together with a new exchange rate with the US dollar. However, this move may have less impact than many hope.
As announced by the People's Bank of China (PBoC), the renminbi, or yuan, will be placed under a "managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies" instead of being rigidly pegged to the US dollar as previously the case. The US dollar will be allowed to fluctuate against the RMB within a band of 0.3 percent around a central parity to be published by the PBoC each day, while other currencies will be given their own fluctuation bands.
As part of the move, the exchange rate of the US dollar against the renminbi was adjusted to 8.11 yuan per US dollar, representing a 2.1 percent appreciation of the renminbi compared with the previous exchange rate of 8.28.
As the Chinese authorities no doubt intended, the sudden move came as a surprise to practically everyone. The surprise was important to prevent speculators from exploiting the move.
Not that there was much to exploit. The revaluation by 2.1 percent was minimal, and for those hoping to see a major revaluation to correct global trading imbalances, it would surely have come as a disappointment.
American politicians, who have been pressing China to revalue the renminbi for some time, tried to put a positive spin on the move. "I welcome China's announcement today that it is adopting a more flexible exchange rate regime," Treasury Secretary John Snow said. Senator Charles Schumer, a New York Democrat who had put up a bill to levy a hefty tariff on all Chinese imports, said that "after years of inaction, this step is welcome", but hoped that there would be more to come. Federal Reserve chairman Alan Greenspan said that "it is certainly a good first step".
Those hoping to see more revaluations or a gradual rise in the exchange rate peg -- a crawling peg -- may be disappointed though. The very next day, the China Daily said in an editorial:
It is difficult to say how closely the editorial reflected official views, but it is clear that China has much to fear from a more substantial revaluation. A large revaluation is deflationary, something that China would not want in view of the large number of non-performing loans in the banking system. In addition, China needs fast economic growth to soak up the large number of unemployed and underemployed people that it has, especially in the countryside.
That it moved at all to revalue could possibly partly have been because of the 9.5 percent growth rate reported for the second quarter. That was probably too much for the authorities, especially with fixed asset investment also rising by 25.4 percent in the first half of the year compared to the corresponding period a year earlier, threatening to overheat the Chinese economy.
The attempt to understand Chinese intentions has not been made easier by the fact that the Chinese have not been clear on exactly how they intend to manage the float. This could be a significant fact.
While many have compared the new exchange rate regime with that adopted by Singapore, which is similar, it should also be noted that the latter maintains a separate monetary policy stance whereby it makes a decision on whether to let the exchange rate rise, fall or stay unchanged against the chosen basket of currencies -- a decision that is announced publicly. So far, the PBoC has made no such policy announcement. Some have taken that to mean that it is being opaque. However, it could also mean that it has no intention of changing the overall exchange rate for the foreseeable future.
In fact, the latter would be consistent with statements made earlier by the PBoC -- on 12 July when, in its first quarter monetary policy report, it had said that the "growth of money and credit remained broadly appropriate" -- and on 19 July when the PBoC said: "We will continue to implement a stable and healthy monetary policy and maintain the steady growth of credit." It would also be consistent with what Zhou Xiaochuan, governor of the People's Bank of China, said at a conference of bankers on 23 July: "China's exchange rate reform won't have too much influence on US deficits."
Furthermore, as many have pointed out, a small revaluation by the PBoC may actually tempt speculators to make bets on further revaluation. Assuming that the PBoC has no intention of rewarding speculators, that it actually made only a small revaluation could indicate that it has no intention of making a big one.
In other words, the 2.1 percent revaluation so far could be all there is to it for some time to come. If so, the total economic and financial impact from the PBoC's move on 21 July would be relatively limited.
The action in the financial markets so far indicates that at least some people believe so. On 22 July, the second day of trading after the PBoC announcement, the US dollar rose almost 1 percent against the yen, partially reversing the Japanese currency's rise of more than 2 percent the day before. The US dollar's exchange rates with other Asian currencies like the Singapore dollar also reacted similarly.
Fixed income securities also saw a turnaround. After falling on 21 July on fears that the renminbi revaluation means less buying of US Treasuries by the PBoC, the 10-year note recovered the next day, the yield falling by 6 basis points to 4.22 percent after rising to 4.28 percent the day before.
Perhaps most tellingly, on 22 July, on its first day of trade after the revaluation, the renminbi actually slipped to 8.1111 from its opening of 8.11.
However, even if the total revaluation turns out to be small, the PBoC's move may still be significant. First of all, it may help defuse political tension with the United States -- as the initial reactions from US politicians suggest -- and thus alleviate protectionist pressures. Secondly, with an exchange rate that is managed against a basket of currencies instead of a fixed peg against the US dollar, the renminbi can now move relative to the latter, giving the PBoC more flexibility in managing the exchange rate as well as in conducting monetary policy. Thirdly, the move should be seen as part of a series of moves by China towards the lifting of capital controls and full currency convertibility.
As it is, the PBoC's move has already had an impact on policy beyond China's borders. Immediately after the PBoC's announcement on the new exchange rate regime, Malaysia also announced that it is lifting its peg to the US dollar and moving to a managed float.
As announced by the People's Bank of China (PBoC), the renminbi, or yuan, will be placed under a "managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies" instead of being rigidly pegged to the US dollar as previously the case. The US dollar will be allowed to fluctuate against the RMB within a band of 0.3 percent around a central parity to be published by the PBoC each day, while other currencies will be given their own fluctuation bands.
As part of the move, the exchange rate of the US dollar against the renminbi was adjusted to 8.11 yuan per US dollar, representing a 2.1 percent appreciation of the renminbi compared with the previous exchange rate of 8.28.
As the Chinese authorities no doubt intended, the sudden move came as a surprise to practically everyone. The surprise was important to prevent speculators from exploiting the move.
Not that there was much to exploit. The revaluation by 2.1 percent was minimal, and for those hoping to see a major revaluation to correct global trading imbalances, it would surely have come as a disappointment.
American politicians, who have been pressing China to revalue the renminbi for some time, tried to put a positive spin on the move. "I welcome China's announcement today that it is adopting a more flexible exchange rate regime," Treasury Secretary John Snow said. Senator Charles Schumer, a New York Democrat who had put up a bill to levy a hefty tariff on all Chinese imports, said that "after years of inaction, this step is welcome", but hoped that there would be more to come. Federal Reserve chairman Alan Greenspan said that "it is certainly a good first step".
Those hoping to see more revaluations or a gradual rise in the exchange rate peg -- a crawling peg -- may be disappointed though. The very next day, the China Daily said in an editorial:
Expectation for a bigger appreciation of the yuan's value was, and will be, unrealistic. Exceedingly drastic response to the change could throw China's and many other Asian nation's economy into chaos, which would be bad news for everybody.
It is difficult to say how closely the editorial reflected official views, but it is clear that China has much to fear from a more substantial revaluation. A large revaluation is deflationary, something that China would not want in view of the large number of non-performing loans in the banking system. In addition, China needs fast economic growth to soak up the large number of unemployed and underemployed people that it has, especially in the countryside.
That it moved at all to revalue could possibly partly have been because of the 9.5 percent growth rate reported for the second quarter. That was probably too much for the authorities, especially with fixed asset investment also rising by 25.4 percent in the first half of the year compared to the corresponding period a year earlier, threatening to overheat the Chinese economy.
The attempt to understand Chinese intentions has not been made easier by the fact that the Chinese have not been clear on exactly how they intend to manage the float. This could be a significant fact.
While many have compared the new exchange rate regime with that adopted by Singapore, which is similar, it should also be noted that the latter maintains a separate monetary policy stance whereby it makes a decision on whether to let the exchange rate rise, fall or stay unchanged against the chosen basket of currencies -- a decision that is announced publicly. So far, the PBoC has made no such policy announcement. Some have taken that to mean that it is being opaque. However, it could also mean that it has no intention of changing the overall exchange rate for the foreseeable future.
In fact, the latter would be consistent with statements made earlier by the PBoC -- on 12 July when, in its first quarter monetary policy report, it had said that the "growth of money and credit remained broadly appropriate" -- and on 19 July when the PBoC said: "We will continue to implement a stable and healthy monetary policy and maintain the steady growth of credit." It would also be consistent with what Zhou Xiaochuan, governor of the People's Bank of China, said at a conference of bankers on 23 July: "China's exchange rate reform won't have too much influence on US deficits."
Furthermore, as many have pointed out, a small revaluation by the PBoC may actually tempt speculators to make bets on further revaluation. Assuming that the PBoC has no intention of rewarding speculators, that it actually made only a small revaluation could indicate that it has no intention of making a big one.
In other words, the 2.1 percent revaluation so far could be all there is to it for some time to come. If so, the total economic and financial impact from the PBoC's move on 21 July would be relatively limited.
The action in the financial markets so far indicates that at least some people believe so. On 22 July, the second day of trading after the PBoC announcement, the US dollar rose almost 1 percent against the yen, partially reversing the Japanese currency's rise of more than 2 percent the day before. The US dollar's exchange rates with other Asian currencies like the Singapore dollar also reacted similarly.
Fixed income securities also saw a turnaround. After falling on 21 July on fears that the renminbi revaluation means less buying of US Treasuries by the PBoC, the 10-year note recovered the next day, the yield falling by 6 basis points to 4.22 percent after rising to 4.28 percent the day before.
Perhaps most tellingly, on 22 July, on its first day of trade after the revaluation, the renminbi actually slipped to 8.1111 from its opening of 8.11.
However, even if the total revaluation turns out to be small, the PBoC's move may still be significant. First of all, it may help defuse political tension with the United States -- as the initial reactions from US politicians suggest -- and thus alleviate protectionist pressures. Secondly, with an exchange rate that is managed against a basket of currencies instead of a fixed peg against the US dollar, the renminbi can now move relative to the latter, giving the PBoC more flexibility in managing the exchange rate as well as in conducting monetary policy. Thirdly, the move should be seen as part of a series of moves by China towards the lifting of capital controls and full currency convertibility.
As it is, the PBoC's move has already had an impact on policy beyond China's borders. Immediately after the PBoC's announcement on the new exchange rate regime, Malaysia also announced that it is lifting its peg to the US dollar and moving to a managed float.
<< Home