China’s recent move to widen the renminbi’s trading band is unlikely to impact the near-term path of the currency, but we believe it represents another important step forward in the country’s financial liberalization. Below, my colleague Anthony Chan explains how a more flexible—and stronger—currency is a vital component of policymakers’ efforts to rebalance China’s export-dependent economy.
A flexible stance
Earlier in April, the People’s Bank of China (PBOC) announced that it would allow the renminbi—also known as the yuan—to fluctuate by up to 1% on either side of the midpoint price against the US dollar set daily by the central bank. This represents a widening of the previous trading band of 0.5% and is consistent with China’s gradual movement along the path of currency liberalization.
Nevertheless, the timing and magnitude of the PBOC’s move came as somewhat of a surprise. In our view, it suggests that Chinese policymakers are becoming more comfortable with allowing the market to play a bigger role in determining the exchange rate, given the official view that after more than six years of gradual appreciation, the renminbi is now closer to its equilibrium value.
The initial evidence appears to back up the view that the Chinese currency’s appreciation is running out of steam: the renminbi has held steady since the PBOC’s announcement earlier in April. However, when it comes to the Chinese currency, we think it’s important to keep an eye on the big picture.
The recent decline in sentiment toward the renminbi has two causes, both of which we view as temporary aberrations—as we argued in a recent blog post. First was a surge in speculative capital outflows from China in the second half of 2011—a trend that has already reversed. Second was a decline in China’s trade surplus in the first quarter, which partly reflected seasonal factors. The surplus bounced back to a healthy US$5.4 billion in March and is likely to recover further in coming quarters.
Nevertheless, it is clear that China’s huge external surplus has been on a gradual downtrend for several years now. It is important to understand why this is so, lest policymakers—and investors—draw the wrong conclusions about the implications.
In recent years, China’s import bill has been swollen by the higher cost of the commodities and minerals needed to fuel its industrialization. At the same time, the price of its manufactured exports has been falling in relative terms, in face of strong global competition and weak demand from the developed world.
A quick glance at China’s bilateral trade trends supports this observation. China’s trade surpluses with the US, Europe and Asia have stayed more or less the same, while its trade deficits with major commodity producing countries and regions have expanded drastically due to rises in both prices and volumes. In other words, the decline in China’s trade surplus has not been caused by a stronger renminbi eroding Chinese exporters’ overseas market share. Rather, it is the result of the impact that rising commodity prices have had on its import bill. What does all this mean for Chinese economic policy going forward, and for the value of the renminbi?
A key challenge for Chinese policymakers is to transition the country’s current growth model—which has been based on very high savings and high rates of investment—to a more sustainable model that is driven primarily by consumer spending and which uses capital more efficiently. As the share of consumption in China’s economy grows, the country’s large external surplus—a major source of trade frictions with developed nations—will start to naturally decline.
However, this shift will not be easy. In its World Economic Outlook this month, the International Monetary Fund (IMF) argued that there has been little progress in China’s economic rebalancing, and forecast that without any further appreciation in the reminmbi, the country’s current account surplus would remain at an eye-catching 4.0%–4.5% of gross domestic product in 2017.
In our view, currency revaluation is a critical policy tool for accelerating China’s rebalancing process. A stronger renminbi decreases the price of imports in domestic-currency terms, raising the purchasing power of China’s 1.3 billion consumers. It would also encourage Chinese manufacturers to continue moving into higher-value industries. And lastly, a stronger currency would help Chinese policymakers ease the inflationary impact of higher energy prices.
The bottom line: despite a muted reaction to the recent widening of the renminbi trading band, economic fundamentals argue for a continued gradual appreciation in the renminbi in coming years.
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.