The movements in Renminbi (CNY)’s cash market FX-rate against USD during the second half of 2014 and the beginning of 2015 show interesting trends. During the period of June 2014-November 2014, the market exchange rate (MER) for CNY against USD rose from 6.27 to 6.13. However from December 2014 until now, the market has seen a constant decline in the market exchange rate for CNY against USD, the current rate has gone down to 6.26.
Why do we have this trend in this particular currency market? What does this trend tell us about the monetary policy of the Chinese central bank? What should the market expect about the trend of this FX-rate in 2015? Will the Chinese currency suffer the same fate of rouble?
To predict the future trend, we first have to explain the past. Fundamentally speaking, the rise of the FX-rate post June 2014 can partially be attributed to the changes in China’s current account surplus. The surplus for China during Q2 and Q3 were 73.3 and 72.1 milliard USD respectively, comparing to 7.1 milliards during the Q1. Among that, the surplus in commodity trade raised from 40.3 milliards in Q1 to the impressive 153 milliards in Q3 according to statistics from Bloomberg.
But why did these improvements fail to maintain the high FX-rate for CNY against USD post November? The answer is simple, but yet few seem to recognise and understand it. The three key sentences that addresses the answer are:
- The recessive nature of the increase in China’s current account surplus;
- The capital outflow from China;
- The changes in the Chinese central bank’s monetary policy.
Even though the Chinese Ministry of Commerce denies the fact that the increase in the current account surplus is actually due to economic recession in China, the statistics speak clearly for themselves. The surplus does not originate from rapid growth in export, but rather is due to the decline in China’s import. The average monthly growth in export declined by 2.9% in comparison with 2013. The average monthly growth of import was much poorer; it showed a decline of 6.6% in comparison with its previous year. It is partially correct to attribute this flatting in import growth to the global price declines of commodities and energy, making it much cheaper to import. However, a decline that is this large and noticeable must also be explained by the economic recession in China and the lowering demands. In conclusion, this increase in China’s current account surplus can’t support the appreciation of CNY in the long-term, due to its recessive nature.
The outflow of capital further helps us to understand the depreciation of CNY. China’s financial account balance declined from a 93.9 milliards USD in surplus in Q1 to a disheartening 9.2 milliards in deficit in Q3. This decline is highly due to the capital outflow from China, and demonstrates the market’s lack of confidence in the Chinese market.
Looking at the official statistics from the State Administration of Forex, it is clear that the market has shown a loss in confidence for CNY already in August. There was a surplus in exchange settlement between CNY and USD from June to August, showing that the corporate and individuals are selling USD for CNY, demonstrating a belief that the currency will appreciate. However the surplus turned into a deficit since August, showing that people are buying USD, which in turns shows an expectation that CNY will depreciate against USD.
If the statistics from trades and flow of capital can help us to understand why the CNY appreciated during the period of June to August, then why did the CNY continue to appreciate despite the outflow of capital? Furthermore, why did the appreciation stop after November? The only rational explanation to this is the change in monetary policy of the People’s Bank of China.
When the flow of capital no longer supported the appreciation of its currency, the Chinese central bank went in and intervened by going against the market. One can only speculate why the central bank acted as it did, but there are a few reasonable explanations to this. First of all, maintaining a stable FX-rate between CNY and USD is crucial for preventing further capital outflow. If the market predicts that the CNY will depreciate, combined with the beliefs that the Federal Reserve will increase its interest rate in 2015, there is a possibility for a more rapid capital outflow from China that can damage the stability of the Chinese financial market. Furthermore, appreciation of the Chinese currency will make the currency and its related assets much more attractive to global investors, thus pushing further the desired internationalisation of CNY.
But as previously mentioned, the CNY started to depreciate against USD after December, showing that the Chinese central bank has obviously stopped with its intervention against the market. This is due to the double-faced nature of the CNY’s appreciation. As the Chinese premier Li Keqiang said: China is facing more and more pressure maintaining its growth. The appreciation of USD during the second half of 2014 was too rapid for China to handle, if China wants to maintain its currency’s FX-rate against USD, then inevitably, CNY’s FX-rate against other currencies will also grow rapidly, this will of course affect the growth in China negatively. It can be said when it comes to maintaining growth or pushing the internationalisation of CNY, the Chinese central bank chose the first one.
These shifting trends lead us to the ultimate question: What will happen to CNY during 2015; will it suffer the same fate of rouble due to the end of People’s Bank’s market intervention? It is reasonable to predict that, although there are still spaces for CNY to depreciate against USD, we will not see a dramatic free fall in CNY’s value like the rouble due to three key reasons.
First all of, the Chinese government’s financial regulatory bodies are very powerful, the government has the ability to stop or at least slow down dangerously rapid outflow of capital by legal forces if they wish to. Also, if we look at the international balance of payment in China, the country will continue to have a surplus in its current balance account and a deficit in its capital account. This doesn’t support further depreciation of the currency. Last but definitely not the least, even though China’s growth is flatting, it still sees a target growth of 7.3% that is unmatchable by most of the countries.
At this moment, one can only speculate about the future. The currency market is very dynamic; the recent case of Russian rouble demonstrates this clearly. One can predict that the CNY FX-rate against USD will remain in the region of 6.2 to 6.4, with a Real Effective Exchange Rate index (REER) shifting in the region of 115 to 135 during 2015. These predictions however, assume that no ultra-significant changes will take place in the macro and microenvironment during the Chinese year of goat!