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China engineers RMB jump in face of rising demand for FX

  • The People’s Bank of China may be driving up the renminbi ahead of an expected US interest rate hike because it has so little room to adjust domestic interest rates. 
  • The PBoC needs a stable exchange rate to control capital outflows; FTCR’s monthly gauge of household demand for foreign exchange rose in May. 
  • Despite commitments to giving market forces a greater role in the economy and the financial system, the central bank for now appears determined to manage the renminbi-dollar exchange rate more closely as vulnerabilities increase.

The People’s Bank of China appears to be behind a jump in the renminbi against the US dollar. Since the start of June, the currency has strengthened 1.14 per cent, according to the mid-point of its 4 per cent daily trading range, which is set each morning by the People’s Bank of China (PBoC).

This is not an unusually large move by the standards of currencies in emerging markets — or even in developed markets — but it is a relatively big move for the Chinese unit, particularly given it has abruptly ended a three-month run of stability against the dollar (see chart). 

There is speculation that the move is a response to the recent downgrade of China’s sovereign rating by Moody’s. Others have posited that the renminbi is catching up on a recent bout of dollar weakness. We believe it is designed to prepare the financial system as vulnerabilities gather ahead of another possible increase in US interest rates when the US Federal Reserve meets later this month. 

Pushing up the renminbi now — the sharp spike in offshore CNH rates (see chart) suggests this is not a market-driven event but one engineered by the authorities — provides a cushion against higher US rates and is a sensible move given how constrained the People’s Bank of China has found itself at home. 

As we have argued, raising domestic rates in lockstep with the Fed to deter outflows is not an option for the Chinese central bank. The leadership’s crackdown on financial market speculation has driven up interbank market rates and pass-through risks hurting the “real economy” borrowers the government is keen to nurture, just as growth appears to be cooling from last year’s injection of stimulus. 

Chinese savers still want their forex

The government is still struggling to contain the demand for foreign exchange assets that fuels the vicious cycle of capital outflows and currency depreciation. Our latest monthly gauge of appetite among Chinese households for foreign exchange found 52.2 per cent of all respondents in May said they would keep at least 10 per cent of their savings in foreign exchange were there no capital controls, versus 44.5 per cent a year ago (see chart).

Our most recent survey of Chinese capital flows found concerns about renminbi depreciation still the leading driver of outflows. But there are capital controls, and more than there were a year ago.

The government responded to intensifying outflows in December by imposing fresh controls, where it had previously been closing loopholes. Despite signs that the government has eased off, and despite its public commitments to renminbi internationalisation and opening up the capital account, the authorities may be ready to tighten further in some areas; the State Administration of Foreign Exchange is demanding that from September banks disclose withdrawals of over Rmb1,000 made from overseas ATMs

Our data show a drop-off in demand for foreign exchange since capital controls were tightened in December, particularly among the highest-income survey group. The proportion of those reporting household income of more than Rmb300,000 a year who would like at least 10 per cent of their savings in foreign exchange rose in May but was below the peak 83.3 per cent recorded in December. 

This may reflect the impact of widespread coverage of the effort to staunch outflows. A more stable exchange rate regime, in combination with tighter capital controls, has dissuaded some savers from trying to increase their foreign exchange holdings. But our data also show that underlying demand to diversify into foreign exchange — across all city tiers and income groups — has risen since the start of 2016. 

Taking back control

The central bank’s intentions behind this burst of renminbi strength remain unclear, but risks are again rising. We have highlighted the difficulties faced by the PBoC in keeping a lid on the interbank system through June. Beyond that, sales in the country’s biggest housing markets are collapsing as the government tightens credit, and prices may follow. This may intensify demand for foreign exchange.

But the central bank is also tasked with maintaining financial stability ahead of a twice-a-decade government reshuffle, and Fed officials still appear keen on tightening US monetary policy beyond this month’s meeting.

The authorities recently flagged the introduction of a “counter-cyclical mechanism” to the renminbi-dollar central parity fixing regime, arguing that this would address market “distortions”. Details are scant, but this smacks of an attempt to take back some control over renminbi pricing. 

This may go against previous reform commitments but is an understandable response from a government whose willingness to give markets a “decisive” role in resource allocation has been decidedly spotty since the Communist Party first promulgated this goal in November 2013. 

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and Southeast Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.