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Stable dollar exchange rate masks ongoing renminbi slide

The Chinese renminbi appears to have been almost glued to the US dollar for most of this year, with the fluctuations in the bilateral exchange rate so minuscule as to be barely worth reporting.

The renminbi’s resultant low profile has served Beijing’s purposes to perfection by lowering geopolitical tensions since the inauguration of Donald Trump, who had threatened to label China a “currency manipulator,” and helping stem the tide of capital flight, which spiked in the wake of the redback’s slide against the greenback in 2015 and 2016.

But, unnoticed by many, Beijing has still managed to engineer an unusually precipitous fall in the real, trade-weighted value of its currency, aiding its army of exporters at a time when its current account surplus is in danger of falling to its lowest level since the 1990s.

Since the turn of the year the renminbi has firmed 1.3 per cent against the dollar after, at the end of last week, breaking out of the tight trading range it has been locked in since mid-January.

However, the redback has fallen 2.5 per cent against a trade-weighted basket of currencies drawn up by the China Foreign Exchange Trade System, an arm of the central bank, taking the currency to a fresh low since the creation of the basket in late 2015, as the first chart shows.

This ongoing slide builds on a 6.1 per cent fall against the basket during 2016, and even this understates the true slide in the value of the renminbi. Given China’s low inflation rate (currently 1.2 per cent), the redback should have been appreciating in nominal terms against most other currencies in the basket in order to maintain its real, inflation-adjusted value.

This comes despite Zhou Xiaochuan, the governor of the People’s Bank, repeatedly stating that keeping the renminbi ”at a broadly stable level” against the basket is the “keynote” of its exchange rate policy.

“The stability of the renminbi to a basket of currencies will be strengthened and the two-way volatility of the renminbi to the US dollar enhanced,” Mr Zhou said last year, prompting the question as to why this is not happening.

“The renminbi has been down consistently against the basket since 2015. They are looking at both the basket and the dollar despite the fact they said they would focus on the basket,” says Lucy Qiu, an emerging market analyst at UBS Wealth Management.

Robert Minikin, head of Asia FX strategy at Standard Chartered, suggests that Beijing may simply be permitting some role for market forces in setting the currency, as the central bank has repeatedly said it intends to, even if, to date, there has been precious little evidence of it actually doing so.

However, a statement from the People’s Bank on Friday appeared to suggest the daily “fixing” of the renminbi’s central parity rate, around which it is allowed some flexibility to oscillate, will be made less dependent on market forces by incorporating a “counter-cyclical factor”.

“The shift seems a step back from efforts to give market forces more say in how the currency is valued. These never went far but now they are going into reverse,” says Mark Williams, chief China economist at Capital Economics.

Alternatively, Mr Minikin points the finger at geopolitics: mild renminbi depreciation against the basket alongside stability in the bilateral dollar rate “is a rather favourable combination for China,” he says, in that it helps to both maintain the competitiveness of China’s exports while allowing the People’s Bank to avoid adopting a path of “competitive devaluation” against the buck.

“According to the latest US Treasury report, China’s goods surplus with the US has totalled $347bn over the last four quarters, far above the ‘currency manipulator’ threshold of $20bn,” says Mr Minikin. “Any ambiguity on China’s FX policy is best avoided amid the heightened focus on trade issues of the new US administration.”

Ms Qiu points to another advantage of this slightly clandestine approach: it does not encourage capital flight, given that most of the companies and households keen on shifting money out of China appear to be focused on the dollar exchange rate.

“Gentle weakening of the renminbi helps Chinese exporters. More importantly, the way they are doing it doesn’t raise a an awful lot of attention. There is no alert in terms of capital outflows. They are achieving the depreciation without the market worries,” says Ms Qiu.

UBS WM’s analysis shows the mechanics of the People’s Bank’s approach. Since the creation of China’s current FX regime in August 2015, the renminbi has fallen 9.6 per cent against the dollar.

In essence, this has been achieved by letting the renminbi weaken on days when the dollar is strong across the board, but not letting it strengthen on days when the greenback is weak.

According to UBS’ number-crunching, on days when the dollar has been up (with the dollar index rising 0.35 per cent, on average) the renminbi has, on average, fallen 0.025 per cent against the dollar.

However when the dollar index has weakened (by an average of 0.36 per cent) the renminbi-dollar rate has typically risen by a negligible 0.01 per cent.

Ms Qiu believes the renminbi’s trade-weighted slide could have further to run, given her belief that Chinese economic growth, at 6.9 per cent in the first quarter of 2017, has peaked, and that the current account surplus will fall to 1 per cent of gross domestic product this year.

UBS’ backdated calculations suggest that had the basket been in existence between 2011 and 2015, the renminbi would have risen against it by 30 per cent.

“It has since weakened by about half of that. Based on historical analysis, I would suggest it will [fall] another 10 per cent,” Ms Qiu adds. “It stops [falling] as the renminbi reverts to fair value against its trade partners. It is maybe 5-10 per cent overvalued by most measures.”