THE DECISION BY THE PEOPLE’S BANK OF CHINA TO widen the trading band for the renminbi could have far-reaching consequences, not only for Chinese currency policy but also for the foreign exchange market, from Hong Kong to Canada to New Zealand. In a long-anticipated move, the PBOC on April 12 announced that it would widen the band to allow the currency to trade as much as 1 percent above or below the daily fixing, up from plus or minus 0.5 percent previously. “The PBOC’s move has a longer-term significance in terms of the currency’s full liberalization,” says Woon Khien Chia, Singapore-based head of Asia foreign exchange strategy for Royal Bank of Scotland Group.
Chia expects that China’s next step will be to let the International Monetary Fund include the renminbi in the Special Drawing Rights, a reserve currency basket that is rebalanced every five years. The IMF is due to carry out the next SDR rebalancing in 2015. Adding the renminbi to the mix, Chia says, could allow for the establishment of long positions against the basket’s other components: the euro, British pound, U.S. dollar and Japanese yen.
In the shorter term widening the trading band means that traders can no longer count on the Chinese currency to invariably follow an upward path. The renminbi has essentially been flat against the U.S. dollar since the start of this year after having risen by a little more than 30 percent since 2005, when Beijing began allowing the currency to appreciate. A narrowing of China’s current-account surplus over the past few years has also eased upward pressure on the currency.
“If you look at a chart of the renminbi, it basically went straight up, and now the band widening says to the market, ‘That’s over,’ ” says Callum Henderson, Singapore-based global head of FX research for Standard Chartered. “The new framework is two-way variability. The dollar-renminbi rate will increasingly react to global market forces, and sometimes it may go up, and sometimes it will go down.”
One implication of this change is that China wants to slow down capital inflows, says David Woo, head of global rates and currency research at Bank of America Merrill Lynch in New York. If that happens, China will be converting fewer dollars into other Group of Ten currencies as it rebalances its currency reserves, Woo explains.
“For every dollar they’re buying against the renminbi, they have to convert a certain portion of those dollars into euros, pounds sterling, the Canadian dollar and other currencies,” he says. “The most important development is that we’re going to see a slowdown in capital inflows into China, and that is actually supportive for the dollar against all these other currencies.”
Another side effect, according to Standard Chartered’s Henderson, is that because the renminbi can go down as well as appreciate in the widened trading band, Chinese companies may face pressure to increase hedging of their foreign currency positions.
“The belief that the renminbi was a one-way bet suggested that Chinese corporates shouldn’t hedge at all,” he says. “Now, with the dollar-renminbi seeing more two-way variability, albeit to a limited extent, there is a greater incentive for corporates to be more active in terms of hedging.”
Given Chinese companies’ vast trading volume, even small changes in hedging behavior can dramatically impact the U.S. dollar–renminbi interbank market, Henderson says. Exporters may sell less of their foreign exchange receipts, and importers may buy dollars instead of borrowing them, he adds, because the renminbi is less likely to appreciate substantially. To the extent that demand for dollars is now more in balance, market forces rather than government fiat will probably determine the onshore renminbi market, Henderson notes.
That idea was underlined in early May when the People’s Daily, China’s official newspaper, published an article stating that “on the basis of value, and balanced supply and demand, the renminbi exchange rate is basically at a reasonable equilibrium.”
Although Washington still insists that the renminbi is undervalued against the dollar, most analysts see its rise slowing compared with the pace of recent years.
Standard Chartered calls for the renminbi to climb some 1.5 percent, to a rate of 6.21 to the dollar, by the end of 2012 from 6.30 last month. RBS expects a 3 percent appreciation for the year, but it adds that this rise depends more on the dollar’s strength against other currencies than on Chinese government policy.
BofA Merrill’s Woo thinks widening the trading band will strengthen the offshore renminbi, which is known as the CNH to currency traders, more than the much bigger nondeliverable forward market. The CNH has been selling at a slight discount to the onshore renminbi, which is known as the CNY, but that may now change, he says. “The Chinese want to promote the use of the CNH as an offshore currency, and eventually the CNH and the CNY are going to converge.” • •
