The renminbi (RMB) has strengthened significantly in recent years. We don’t think it will continue to appreciate at the same pace, and in the very short term we may see two-way volatility in the exchange rate. But we are still positive on the currency, especially in the medium term. Here are five reasons why.
1. The RMB will internationalize—maybe faster than many people think
China is the world’s largest exporter—bigger than the entire euro area. It is also the world’s second-largest importer. In real terms, its share of total global real GDP climbed from 4.3% in 1992 to 14.4% by 2010. Yet China’s currency accounts for less than 1% of foreign-exchange trading volumes. But there are signs that this is changing rapidly. For example:
- In 2010, China settled just 2.6% of its own global trade in RMB. By 2011 that had risen to 8.1%.
- This year, the London Metal Exchange consulted its members on offering settlement of its financial contracts in RMB, possibly at the expense of sterling settlement.
- SWIFT payment systems reported that 4% of letters of credit (LC), which facilitate goods trading, were denominated in RMB, making it the third-largest largest currency denomination for LCs after the US dollar (84.4%) and euro (7%).
Internationalization of the currency and its development into a global reserve currency are key objectives for the Chinese government. But how fast can this happen? The US dollar only became a currency of international settlement in 1913 with the establishment of the US Federal reserve system. In just 15 years it surpassed the British pound as the preferred settlement currency for international trade. And the euro, now the second most widely traded currency, didn’t even exist before 1999.
2. A stronger RMB hasn’t held back China’s exports, so don’t expect it to reverse its currency policy
Since 2006, the renminbi has appreciated by about 24% against the US dollar. Chinese exports have continued to grow despite the currency’s appreciation, albeit at a slower pace (10% in 2011 compared with 24% in 2005). And this was against the backdrop of the global financial crisis and economic slowdown. The stronger RMB has also helped contain import-price inflation. This has assisted the government in its goal of rebalancing its economy more towards domestic consumption, and it potentially helps China move up the value-added chain in its export manufacturing by lowering the cost of imported intermediate goods.
3. It’s not just about the RMB versus the US dollar
Although the pace of the renminbi’s appreciation against the dollar has slowed, the RMB has appreciated 21% against the euro in the wake of the euro sovereign crisis.
On the other hand, any country with a significant trade deficit with China, or with large export markets competing with China’s, will continue to put pressure on China to allow the RMB to appreciate versus global currencies generally, and its own domestic currency specifically. While the RMB has appreciated in a controlled fashion against the US dollar, managed by the People’s Bank of China (PBOC), it has not appreciated as smoothly against other major currencies. Over the last few years it has actually depreciated against the yen and Australian dollar.
4. A stronger RMB will help the Chinese government achieve many of its long-term objectives
Central bank governor Zhou Xiaochuan, when asked recently whether the RMB had reached its “equilibrium” value and whether appreciation was over, said: “I am afraid it is not that simple.”
He was referring to the fact that the Chinese authorities are balancing a number of objectives, including managing the domestic economy, placating the US (a stronger RMB would partially address imbalances between the two countries by making the US more competitive relative to China) and encouraging foreigners to hold RMB assets. All of these goals would be more easily accomplished with a rising exchange rate.
This balance of longer-term interests has not changed. Incomes and productivity in China are still rising, which will push up price levels and the currency over time; China’s trade and currency practices are still a live issue in US domestic politics; and the RMB still represents a tiny portion of global currency trading and reserve assets.
So we think China will continue to aim at trend currency appreciation. Importantly, we feel China is playing the long game in its thinking and how it balances short-term considerations.
5. Developing RMB capital markets will support further currency appreciation
Historically, the Chinese market has been closed to foreign investment, but it is gradually liberalizing and its capital markets are developing—notably the “Dim Sum” (offshore RMB) bond market. As it does, we would expect foreign investment capital inflows into China to outweigh Chinese capital outflows into foreign markets. Lending further support to this argument are the fundamentals of China’s economy: favorable demographics and a growing middle-class consumer base; fiscal flexibility afforded by low debt and debt-service ratios; and room to reduce central bank policy rates to further stimulate growth as inflation declines.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Hayden Briscoe is Director of Asia Pacific Fixed Income at AllianceBernstein.