RMB – A position of strength
As the market digests The People’s Bank of China’s (PBoC’s) announcement late last week to scrap the 20% FX reserve requirement on Renminbi (RMB) FX swap and options transactions, it is all too easy to conclude that this necessarily means more volatility for the Chinese Yuan, and that the authorities are opposed to further RMB appreciation. It is unsurprising, therefore, to see knee-jerk reactions in both onshore and offshore RMB against the US dollar. However, as we have been arguing for some time, the analysis of China through the usual market lens results in black-and-white conclusions, when in fact the reality lies somewhere in between the extremes. Whilst the RMB has appreciated over 6% against the US dollar year-to-date, DXY has lost closer to 7%. On a trade-weighted basis, as reflected by the China Foreign Exchange Trade System (CFETS) RMB Index, the RMB remained weaker on the year until last week.
A more rapid pace of currency appreciation over the last month has been driven by a number of factors, including an increased desire by Chinese exporters to convert foreign currency back into RMB, as well as a growing onshore confidence in economic stability. Against the backdrop of Chinese FX reserves holding stable above the $3trn mark, and a local economy continuing to grow at 6.5% in spite of financial deleveraging and regulatory tightening, the relaxing of FX reserve requirements should not be mistaken for a desire to see a weaker currency by the PBoC. Rather, this position of strength provides an opportunity to build on the momentum of the Yuan gaining status as an international reserve currency. Recall that in July, MSCI finally granted inclusion of China A-Shares into the index. China hopes that such decisions which appear to allow free market forces to determine the value of its currency and will eventually lead to China’s inclusion in major global bond indices in time. Whilst these measures are unlikely to be enough, they certainly don’t hurt.
The removal of the 20% reserve requirement reduces the cost of hedging RMB currency risk, but does not by itself create an additional need to hedge. The public shaming of various Chinese corporates and their “conspicuous” offshore investments creates, if anything, a need to convert offshore proceeds back into RMB. Further, the reduction of hedging costs combined with initiatives such as Shanghai-Hong Kong Stock Connect and Hong Kong Bond Connect may in fact entice more foreigners into the onshore Chinese market. Similarly, the PBoC is rumoured to be contemplating the removal of the 17% Reserve Requirement Ratio (RRR) – the amount of cash that banks are required to hold – on major offshore banks’ RMB holdings onshore. This was also once a deterrent to betting against the Yuan, yet with recent CNH liquidity so flush, such a measure is unlikely to produce much response in spot FX rates, but succeeds in making China appear increasingly market friendly.
The PBoC is more concerned with the recent pace of RMB appreciation, rather than currency appreciation itself. Whilst the removal of the FX reserve requirement allows the currency to pause for breath, we believe it is not the PBoC’s intention to reverse the RMB’s course. As the Chinese economy transitions from a growth model reliant on old economy industries to one led by domestic demand, import growth is likely to outpace exports, as we have already started to see. Almost two-thirds of Chinese GDP growth this year has been driven by domestic consumption. A stronger RMB serves to benefit such an economic model, and isn’t it ever so helpful that it also appeases the Trump administration and its fixation on currency manipulators?