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Who Will Benefit from the Revaluation of the Yuan?
04/15/2010 12:01 am EST
US Treasury Secretary Tim Geithner's unscheduled meeting to Beijing on April 8 and the postponement of the deadline (originally April 15) for a US review of China's currency policies rekindle speculations that the Chinese government will allow the renminbi (RMB, CNY, yuan) to appreciate.
In July 2008, China re-pegged RMB near 6.83 per USD as a means to help its exports weather the global financial crisis. The People's Bank of China also signed currency swap deals with Malaysia, Hong Kong, South Korea, Indonesia, Belarus, and Argentina. However, as global economy recovers with growth in China particularly strong, the country has been facing pressure, especially from the US, to abandon its exchange rate peg regime.
Benefits to China
While the market has focused on US pressure on China to revaluate RMB, China itself will also benefit from the revaluation.
We believe gradual appreciation of RMB is part of the Chinese government's plan to unwind its monetary stimulus. Allowing the currency to rise modestly can help contain inflation, lower import price pressure generated from a surge in commodity prices, as well as cool down threats from trade protectionism.
Average CPI in January and February surged +2.1% y/y from the same period last year, reinforcing the uptrend on inflation. Although the fast-expanding inflation in China has triggered the central bank to tighten reserve requirements twice this year and limit bank lending, the impacts of these measures were not that significant. Besides, PPI jumped +4.9% y/y in January and February, following a rise of +1.7% in December. Acceleration in PPI in the first two months of 2010 was driven by rallies in global commodity prices, and higher input prices will be passed to consumers in coming months. Added to the government's concerns is the +10.7% increase in residential property prices in 70 major cities in January. Heightened inflationary risks suggest to the government that steady appreciation in the currency should be favorable.
The Chinese government has hoped to see sustainable export recovery before revaluating RMB. As driven by strong domestic demand, China's import growth outpaced that of exports. In March, China recorded a trade deficit of US $7.2 billion for the first time in six years. Imports surged +66% y/y during the month (+63.6% in January-February), while exports grew moderately by +24.3% y/y. For 1Q10, China recorded a smaller trade surplus at $14.5 billion, down -76.7% from the same period last year.
Despite this, balance of payment in China should remain surplus in the long term. Moreover, RMB appreciation does not necessarily reduce the country's surplus. In fact, RMB soared +21% against USD from July 2005 to July 2008. During the period, China's surplus surged to a record $296 billion.
MORE: Impact of RMB Appreciation on Other Currencies|pagebreak|
Now that the possibility that China will be named a “currency manipulator” by the US Treasury in the semi-annual report is quite low, China is willing to adjust/increase the flexibility of its exchange rate regime. The Chinese government is aware that escalating tensions between China and its trading partners is a “lose-lose” situation. While China strongly prefers the status quo, a modest revaluation reduces the risk of trade protectionism or even a trade war from trading partners.
Moreover, appreciation in RMB will help rebalance China's economic growth structure from reliance on exports to domestic demand. As RMB appreciates steadily, foreign demand for China’s goods will decrease as they get more “expensive.” This will make producers focus less on export markets. Rather, they will concentrate more on the domestic market. Domestic consumption will also be lifted as a rise in the domestic currency increases purchasing power in local currency terms.
Allowing the RMB to appreciate is the first step for China to move to a more flexible and independent monetary regime. Currently, the People's Bank of China is facing difficulties implementing monetary tightening, such as rate hikes, even though it is necessary to prevent economic growth from overheating and inflation from getting out of control. The market has been speculating that the RMB would appreciate “someday.” Therefore, ample capital has been flowing into the market. Excess liquidity is what the government needs to manage in the current situation. The government does not want to raise interest rates unless the Fed has taken the lead because widened interest rate spreads would attract even more capital inflow to China. The government should allow some forms of appreciation in RMB so as to discourage speculative inflows, and in the longer term, to adopt a monetary regime that is independent of the US.
Impacts of RMB Appreciation on Currencies
If China were to appreciate its currency, we believe most Asian currencies (with the exception of the Japanese yen and Hong Kong dollar) would benefit. Currencies from Taiwan, South Korea, and Malaysia should be lifted because they are large exporters to China. These currencies should rally without fear of losing competitiveness.
Look at the Malaysian ringgit (MYR). The currency surged +7.4% against USD this year and has been (so far) the best performers in the world after the Costa Rican colon.
In March, Malaysia's central bank raised its benchmark interest rate to 2.25% from a record low of 2%, becoming the second Asian country, after India, to increase borrowing costs as the economy recovers from recession. The central bank also said that the country's GDP in 2010 may grow “1%-2% more” than its March forecast of at least 4.5%.
While Malaysia adopts a similar exchange rate policy to China, policymakers are more relaxed in seeing the ringgit appreciate. We believe stronger fundamentals in Malaysia's economy should give the currency a further boost.
MORE: Impact on Euro, USD, and Commodity Currencies|pagebreak|
RMB appreciation is expected to be detrimental to the euro from the perspective of reserve diversification. According to the International Monetary Fund (IMF), the euro's share of global reserves was 27.4% by the end of 2009, compared with 26.4% in 2008. While it remains a distant second to USD (62.1%), the rising trend has supported the euro's appreciation.
However, the sovereign crisis in Greece and deficit issues in peripheral European economies has unveiled structural problems in the single currency, and its attractiveness as an alternative to USD has been reduced.
As a means of reserve diversification and weakening domestic currency, China has been accumulating the euro. Should China revaluate its currency, such process will be slowed down and the euro will get hurt.
We are still uncertain about the net impact of RMB appreciation on commodity currencies such as AUD, CAD, and NZD. On one hand, an appreciating RMB should support commodity prices and improve terms of trade of these commodity exporters. On the other hand, currency appreciation can be regarded as a sort of tightening and may increase concern over China's growth outlook as well as demand for commodities.
In short, recent development suggests that a gradual appreciation in RMB is imminent, and we believe the process will take place in the coming few months. Investors should monitor the situation closely and act appropriately.
By the Staff at ActionForex.com
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