The People’s Bank of China (PBoC), the country’s central bank, has stated that the depreciation was due to a technical change to the manner in which the reference FX rate between the RMB and USD 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/demand dynamics and expectations.
In a bid to move to a more market-driven approach, the PBoC explained that the change was intended to be a one-off adjustment to address the misalignments. In a subsequent press conference, the PBoC provided further clarity to its position. Among other things, it reiterated that China’s strong fundamentals should provide good medium-term support for the RMB to continue on a broad direction of appreciation. The PBoC also stated that it is willing to intervene to counteract significant and unjustified moves in the currency.
Perspective
From our perspective, the PBoC’s move to a more market-oriented exchange rate scheme is an important requisite for the RMB to be considered as a constituent of the IMF’s SDR currency basket, or to serve as a reserve currency more broadly.
The recent adjustments, therefore, likely form part of the Chinese government’s objective to promote further internationalization of the currency. In addition, relatively loose liquidity conditions in recent periods have resulted in some short-term negative pressure on the RMB.
While the depreciation of the currency in recent days has been quicker and more pronounced than our outlook of 1-3% for 2015, it does not cause us undue concern or materially impact our long-term outlook.
Stabilise
We anticipate that the RMB will stabilize 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 USD300 billion, 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 RMB in the near term.
Looking ahead, further flexibility in the RMB is probable as the PBoC continues to embark upon its trajectory of market-based financial reforms.
Ironically, while the policy direction is quite clear in this regard, 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 bears monitoring, while also remaining cognizant of the drivers of such volatility.
