How China celebrated its yuaniversary

The change lead to an immediate devaluation of the currency, catching market participants by surprise and causing significant cross-asset volatility in global financial markets. This day is often referred to as ‘811’ in deference to the significance of what happened on that day, the 11th of the month.

" The last year has been a roller coaster for the RMB and China still has work to do."
Daniel Everett, Global Head of RMB, Strategy & Execution, ANZ

We have just celebrated – or maybe commemorated - the ‘yuaniversary’ of 811. So what has changed and how have China’s exchange rate reforms and policy measures impacted the renminbi (RMB) and overall liberalisation process?

WHAT’S CHANGED?

Before the reform, the daily fixing rate of the onshore RMB (referred to as ‘CNY’) versus the $US was largely opaque and considered artificial.  The spot rate often traded at a significant variance to the fixing indicating market forces did not believe the fixing to be a true representation of the currency’s value.

The main policy intent of the change was to reform the process and shift to a managed floating exchange rate system where the daily fixing referenced the previous day’s closing $US/CNY spot price.

When the change happened, the fixing immediately set to a lower value to match the market price and while the authorities did try to explain the new measures to the market, this communication largely fell on deaf ears.

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Weaker fixings in line with the new framework over the following days were interpreted by the market as a deliberate devaluation of the RMB and that China’s authorities wanted a weaker currency.

Concerns of an imminent regional currency war and potential deflationary impacts worried markets. These concerns manifested into significant turmoil in global financial markets and forced the People’s Bank of China to expend significant amounts of foreign exchange reserves to help stabilise the RMB. It was a time of volatility discussed in this podcast and analysis.

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There is little doubt China wanted to move to a more market-determined exchange rate.  In addition, China knew in November 2015 the IMF was going to determine if the RMB met the criteria for inclusion in their Special Drawing Rights basket. With this in mind, the authorities felt it was timely to progress with exchange rate reforms. 

It is clear, however, the process did not go as planned and the PBoC was forced into damage control to limit a disorderly weakness in RMB and a flood of capital leaving China.

Such damage control did not stop at direct intervention in the foreign exchange market but also resulted in a clamp down on capital outflows and implementation of punitive margin requirements on forward RMB sales.

RMB INDEX

A new round of currency weakness and volatility occurred through December 2015 and January 2016 after the PBoC announced the RMB would be assessed against a trade weighted basket of currencies using a new RMB Index. 

The PBoC wanted to take the focus away from the prominent bilateral USDCNY rate and view the RMB’s performance against currencies of its major trading partners. Market participants interpreted this as a potential cover for further currency depreciation so previous concerns re-emerged.

Since then, the RMB has been far more benign from a volatility perspective, although weakness has persisted against both the USD and to a greater extent against the trade-weighted RMB Index.

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However, despite these moves, markets have been much less concerned than previously. Why?

The moves in August 2015 and to a lesser extent in January 2016 caused markets to panic because they did not understand the PBoC’s motives and misinterpreted the ultimate objective.

It also caught the market by surprise and had little, if any, forewarning. Financial markets do not like surprises, particularly when it comes to a large market like China that is trying to integrate with the world and build trust and credibility with the global community.

Secondly, economic conditions globally and certainly in China warranted a weaker RMB and in fact, the USDCNY spot price had traded much weaker than the PBoC fixing in the lead up to the change indicating markets felt the RMB was overvalued.

In addition, the RMB had been on a constant .trend over the past decade so some retracement was inevitable as China embarked on supply side structural reform and overall GDP growth slowed.

Finally, the currency wars and deflationary pressures that markets feared from a weaker RMB have yet to eventuate.  A weaker RMB should theoretically make China a more competitive export nation but it wasn’t clear that a stronger RMB had caused any decline in China exports previously.

In short, the market calmed down and the measures introduced by the PBoC to limit capital flight and cross-border foreign exchange arbitrage significantly reduced RMB volatility. The PBoC’s direct intervention in the onshore and offshore foreign exchange markets also stabilised movements.

But at what cost? And how has all this left the RMB in the eyes of the global community?

DOUBLE-EDGED SWORD

It is really a double-edged sword at the moment.  On the one side, the daily fixing is much easier to predict and in normal markets, the USDCNY spot rate operates in accordance with the PBoC’s ‘managed floating basis’ objective. The world has become generally comfortable with the RMB’s valuation and better understands how the framework operates.

On the other side, market participants are certainly wary China can still be unpredictable and while the PBoC has less flexibility to manage the currency through the daily fixing, it has certainly shown its willingness to flex its muscles through intervention and other measures to promote stability ahead of any other priority.

That’s where we are at the moment. Stability is currently trumping a more liberal currency and RMB internationalisation regime; this is possibly a sensible position for the moment.

China is not in a hurry and will progress with liberalisation to the extent markets can absorb the changes with minimal volatility and stress. RMB internationalisation and foreign exchange reform will remain key pillars in China’s future.

The last year has been a roller coaster for the RMB and China still has work to do to build the necessary trust with investors and other participants required for greater RMB usage globally.

Developments over this time, however, represent necessary and painful steps towards a more open financial system with a free-floating exchange rate and free cross-border capital flows.

China still has a lengthy and complex liberalisation journey ahead and while the pace has clearly slowed for the time being, China is very much playing the long game.

Daniel Everett is Global Head of RMB, Strategy and Execution at ANZ

ANZ, in partnership with the Financial Times will be hosting the next installment of the FT-ANZ RMB Growth Strategy Series in London on September 22. For further information click HERE.