The dollar rallied as high as 6.8869 versus the renminbi on Tuesday after settling earlier at 6.8525.
While it’s not a major move, it does decisively break the government-supported range of 6.8037-6.8808 held onto since July. It’s also the second signal of a government-supported depreciation, as the PBoC changed its mid-point for the USD/CNY reference rate to 6.8505 from 6.8349 on Monday.
All this is leading to much speculation that the Chinese are actively reversing their policy on renminbi appreciation. If true, it would certainly mark a significant policy shift. It could also suggest the Chinese economy is in much worse shape than many have expected. Some analysts are now forecasting the USD/CNY cross rate could move as high as 6.90-6.95 by mid-2009, this as China tries to boost the competitiveness of its exports which are clearly suffering due to the global slowdown.
As RBC Capital markets points out in its note “CNY depreciation now on the policy menu?” Manufacturing PMI data released Monday showed heavy falls in November (See chart below). Unemployment is also rising quickly, with a senior minister last week warning that the official rate could head north of 4.5 per cent next year.
The Chinese, of course, have already taken a number of measures to help stimulate the economy and lessen credit restrictions via both monetary and fiscal policy tools. These includes reducing the benchmark one-year lending rate by almost 200 pts since September as well as introducing a large fiscal stimulus package just last month.
Would they now risk aggravating the likes of Henry Paulson with a complete reversal on USD/CNY rate policy? Potentially, say RBC:
So far, however, the exchange rate has provided only limited support to growth and the beleaguered export sector. For several years, USD/CNY has been on a gradual but consistent downward trend, reflecting both long-term strategic goals by the Chinese government, pressure from the United States and, more recently, the need to combat inflation. With the focus shifting decisively from inflation to growth in recent months, the fall in USD/CNY has stalled on a bilateral basis at around 6.82-6.84, providing some relief to exporters, but USD strength has meant that the yuan has continued to gain on a trade-weighted basis — against the euro, the currency of China’s largest trading partner, the yuan has appreciated almost 25 percent since mid-year. This has prompted speculation that a weaker yuan might be part of the policy response.
Although, even RBC cautions a one-day change in the mid-point is not enough to demonstrate a shift in policy just yet. They see it more as the government trying to gauge market sentiment ahead of major policy meetings to be held this month:
The currency will clearly be a major topic of discussion at these meetings, so policymakers may find it useful to have some sense of the likely response to a weaker yuan beforehand. Treasury Secretary Paulson, due to meet senior Chinese officials this week, will no doubt have an opinion!
It’s true that any significant policy reversal could bring about a major shift in Chinese-US relations. But as some analysts speculate it could also be that China sees a unique window of opportunity before the new administration comes into place in January. However, the risks are more than political - it could also lead to significant capital outflows by investors.
Standard Chartered agrees that for the moment renminbi depreciation looks good in theory but not in practice - the current devaluation, they say, is likely a reaction to recent trade-weighted strength more than anything else:
There is a theory being put out in the market that there is a desire to weaken the Chinese yuan (CNY) now so that there can be some appreciation after President-elect moves into the Oval Office on 20 January. The fact is that by our estimates the CNY real effective exchange rate (REER) reached a 20 year high in October and so even some modest weakness now against the USD is still consistent with a trade weighted appreciation policy.
The move may also be some reaction to pressure to take action to help out exporters. We believe that such a move in the currency will do little to help exporters in the current global growth environment, especially as it may be met with reactions from other regional currencies. This move will also help to remove some of the ‘one-way bet mentality’ from the market. We had been expecting to see some modest weakness in the CNY in H1-09. The 1M, 3M and 1Y NDFs are currently indicated at 6.99, 7.11 and 7.31 mid.
Related links:
The China syndrome - FT Alphaville
When is Chinese GDP not Chinese GDP - FT Alphaville
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