So China moves to flexibility in the renminbi, presenting a token diplomatic gesture before G20 talks, but ultimately not changing very much economically. Right?
Well, sort of. The situation is more complex than that.
According to Stephen Lewis of Monument Securities, the motivations behind the move went beyond pleasing the G20 (emphasis FT Alphaville’s):
Cynics are saying that the timing of the statement reflected China’s concern to disarm its international critics ahead of this week’s G20 summit meeting. It would be naïve, however, to suppose the Beijing leadership is responding to G20 exhortations that it should act in the global interest…
Chinese officials have successfully resisted intense pressure on the RMB before – not least being dubbed a ‘currency manipulator’ by 130 US lawmakers back in March.
So what is really going on? According to Lewis, there is a wider story:
The fact is the yuan’s dollar peg has not been effective, over the past few months, in helping to insulate Chinese exporters’ profit margins from currency fluctuations. The US dollar has been appreciating against other currencies, most notably the euro, and the peg has pulled the yuan up with it. As a consequence, the yuan has appreciated, in SDR terms, since the end of last year by some 6%. Breaking the peg will allow the yuan to avoid any future appreciation that would occur if the US dollar continued to rise against the euro and other currencies. In other words, the ‘flexible’ policy will allow China to avoid further loss of competitiveness in the euro zone. It may turn out that unpegging the yuan will result in a rise in the yuan/dollar exchange rate, only if the US dollar weakens overall.
Which suggests that renminbi flexibility won’t change China’s trade position very much, and that much else depends on events in the euro and dollar.
Plus — as IFR Markets’ Divyang Shah notes — Chinese FX reserves might still increase even without intervention to buy dollars under the fixed peg. This is thanks to the People’s Bank of China’s ongoing bid to sterilise hot money inflows:
…what we might see is actually increased inflows now that the CNY is “in play”. The initial de-pegging in July 2005 saw FX reserves increase by 15.2bn in the 24-months prior to the move compared to 27bn in the 24-months after the move. The FX reserve increases, as a proxy for increased hot money inflows, highlights that the demand for USD and USD-denominated assets will remain firm.
After all, Shah adds, the euro isn’t such a viable alternative versus the dollar at the moment for reserve managers who are worried about eurozone sovereign debt.
Which again shows that FX reserve managers, Chinese or otherwise, aren’t in an enviable position right now.
Related links:
Renminbi ruminations – FT Alphaville
Will China now suffer a tidal wave of capital inflows? – FT Beyond Brics
China’s yuan head fake - China Real Time / WSJ
Stop the Chinese steamroller, I want to get off – FT Alphaville