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The Renminbi Escapes an Emerging-Markets Currency Rout

Low volatility and China’s big trade surplus could help keep the currency rising against the U.S. dollar this year, says HSBC's Paul Mackel.

Only a month into the New Year, many emerging-markets currencies were plunged into turmoil by the U.S. Federal Reserve Board’s tapering policy. But one stood out, gaining as its rivals plummeted: the Chinese renminbi. “India, Indonesia, Thailand, South Africa and Brazil are all blowing up, while China remains pretty solid,” says Stephen Green, Hong Kong–based head of research for Greater China at Standard Chartered Bank. “One of the reasons for that is that China runs this big trade surplus.”

China’s trade surplus rose 12.8 percent in 2013, to $259 billion, bringing a flood of dollars into the country. The surplus continued to swell at the start of this year, reaching $31.9 billion in January, up 14 percent from a year earlier.

Surpluses don’t guarantee a rising currency. South Korea and Taiwan posted big surpluses last year too, but their currencies got battered in the emerging-markets sell-off. What distinguishes China is that its surplus goes hand in hand with a government policy of managing the exchange rate to ensure a moderate, steady appreciation. After adopting a managed float in 2005, the People’s Bank of China allowed the currency to rise by about 20 percent against the dollar over the next three years, then effectively fixed the rate for two years to help stabilize markets during the global financial crisis. Since 2010 the central bank has allowed the currency to rise by roughly 2 to 3 percent a year. It gained 3.1 percent in the 12 months ended February 12, to 6.10 to the dollar.

“You have two forces of competing flows that are compressing the volatility in the exchange rate,” says Paul Mackel, head of Asian foreign exchange research at HSBC Holdings in Hong Kong. “There is pressure in the form of trade and other inflows, but on the other hand the expected intervention by the People’s Bank of China is limiting appreciation pressure.”

Lately, the Chinese authorities have been trying to increase renminbi volatility, so far without apparent effect. In April 2012 the PBoC widened the daily band in which the currency is allowed to trade, from 0.5 percent to 1 percent. But the prospect of intervention keeps speculators from bidding far from its daily fixing. “If the PBoC didn’t intervene, the renminbi would appreciate sharply and then they’d get blamed by other ministries who would say they weren’t managing things properly,” Standard Chartered’s Green says. China’s reserves surged by $166 billion in the third quarter of 2013, to $3.66 trillion, suggesting that the central bank was actively buying dollars in the period.

After the Third Plenum of the Communist Party’s Central Committee endorsed a call for new, market-oriented reforms in November, the authorities said they were determined to broaden the trading band. But some analysts are skeptical that the government will change its exchange rate policy. “It’s going to be a big challenge to actually see this currency rise in stature in a global financial system but then have such a low level of volatility,” Mackel says.

Green says the renmimbi’s lack of volatility has made it an attractive hedge fund trade. Its deviation from the average price over the previous three months hit a low of 1.62 percent in late January, compared with 5.07 percent for the South Korean won and 7.71 percent for the Japanese yen. “The low volatility almost encourages people to bet on appreciation,” Green says. “You see a lot of dollar selling because of that.”

In addition, interest rates in China are relatively high. The overnight interbank rate stood at 6.54 percent in late January. Although that’s lower than some other emerging markets, which have hiked rates to defend their own currencies, the Chinese rate is attractive to hot money flowing from overseas. (Although Beijing imposes strict capital controls, overseas money can reach Chinese banks through their affiliates in Hong Kong.)

Another factor in the renminbi’s appreciation is the Chinese government’s attempts to internationalize the currency for use in trade transactions, which is supposed to lessen reliance on foreign currencies, especially the U.S. dollar. The U.K. set up an official swap line with China in 2013, and a handful of other countries, including Indonesia, Malaysia and South Korea, have done the same. But the program is having a strange effect at home. Use of renminbi for trading is higher among Chinese importers than exporters, skewing the trade toward more U.S. dollar selling, according to HSBC, and adding to the appreciation pressure on the renminbi.

The Chinese government may desire a stronger currency to foster the shift from an export-led economy to one focused more on domestic consumption. “An appreciating currency helps imports and consumption, but you don’t want the currency to strengthen too quickly compared to its main trading partners because the next day China’s exports could feel the pressure,” HSBC’s Mackel says.

Mackel and Green see the trend continuing at least until the end of the year. HSBC predicts that the renminbi will close 2014 at 5.98 to the dollar, while Standard Chartered is looking for 5.92. • •

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