China’s recent devaluation of the renminbi has created waves in global markets, but appears to be in line with the government’s long-term goal of internationalising the currency.
The People’s Bank of China (PBoC) has stated that the depreciation was due to a technical change to the way in which the reference rate between the Renminbi and US Dollar is determined. In the past, the central bank’s views largely determined the rate, creating some misalignments with the spot rate, which tends to be driven by a combination of supply and demand dynamics and expectations.
In a bid to move to a more market-driven approach, the PBoC said that the change was intended as a one-off adjustment. The PBoC went on to provide further clarity to its position, and among other things reiterated that China’s strong fundamentals should provide good medium-term support for the Renminbi to continue on a broad direction of appreciation. The PBoC also said it is willing to intervene to counteract significant and unjustified moves in the currency.
From our perspective, the PBoC’s move to a more market-oriented exchange rate scheme is an important requisite for the Renminbi to be considered as a constituent of the IMF’s Special Drawing Rights currency basket, or to serve as a reserve currency more broadly. The recent adjustments, therefore, likely form part of the Chinese government’s aims to promote further internationalisation of the currency.
In addition, recent relatively loose liquidity conditions have resulted in some short-term negative pressure on the Renminbi. While the depreciation of the currency in recent days has been quicker and more pronounced than our outlook of 1 per cent to 3 per cent for 2015, it does not cause us undue concern or materially impact our long-term outlook.
We anticipate that the Renminbi will stabilise in the near term, due in part to the strong year-to-date trade surplus. For the first seven months of 2015, China’s trade surplus stood at over $300bn, partly due to the stability of imports and lower cost of imported materials. This, in conjunction with China’s record foreign currency reserves, should provide a good degree of fundamental support for the Renminbi in the near term.
Looking ahead, further flexibility in the Renminbi is probable as the PBoC continues to embark upon its trajectory of market-based financial reforms. However, while the policy direction is quite clear it may also result in additional volatility in the exchange rate, and capital markets more broadly, as the various financial reforms unfold and take shape. We believe that the situation needs to be monitored, while also remaining cognisant of the drivers of such volatility.
Frank Yao is senior portfolio manager on the Neuberger Berman China Equity Fund