Like most, we expect the renminbi to appreciate following the shift from a currency peg. But we think that the pace of change won’t make a big difference to China’s trade surplus or its inflation rate.
Earlier this year we made the case for the Chinese bowing to external pressure to free up the renminbi this spring.
There were two main reasons for expecting a move. First, the huge current account surplus that China has been running – and which other nations at the G20 have been arguing warrants a greater shift towards balance in order to more fairly bear the burden of the financial crisis. Second, the Chinese economy has also exhibited signs of having problems of its own, in the form of rising inflation.
A shift from using a currency peg, to let market forces drive the renminbi (RMB) higher, would help to both limit China’s competitiveness (and hence her trade surplus and the pressure from overseas to “play the game” in terms of burden-sharing), but also help reduce price pressures at home.
The Greek crisis led, amongst other things, to a big drop in the trade-weighted value of the euro – which therefore also meant an appreciation of the renminbi. The Chinese appeared to be using this move as an excuse to go cold on the idea of returning to a “dirty float” of the renminbi – or as some people call it a “crawling peg”. (In other words, rather than let the currency float by itself – driven by market forces – the authorities set limits for how much the currency can move before they restrict its value, say by 1/2% per day.) Thus, like many analysts, we had been thinking of pushing out our “spring” move to the autumn or later in our next edition of Signpost, due for publication early next month.
In fact, the authorities announced on Saturday that they had decided to make a further reform to the RMB exchange rate regime, in effect going back to the pre-financial crisis regime that they employed – with daily bands within which the currency can move of 0.5%. By not changing the central rate of this band from the current dollar exchange rate (of 6.826 RMB per dollar), however, the authorities chose to signal that they do not see the currency as needing to appreciate.
Going ahead, most people see a rise in the renminbi as inevitable. We agree. But, the authorities will still determine how much market forces will be allowed to be brought to bear to push the currency higher. We suspect that a 5% appreciation over the next year – which would take it to about 6.60 by the middle of next year – is the sort of pace that the Chinese authorities would find acceptable, and would be seen by other G20 countries as “playing the game”.
Such a pace of change will not make a huge difference to either the trade surplus or to Chinese inflation. (It is just too small a shift to alter, meaningfully, either trade flows or consumer prices.) But, it does show that, after a lot of push and shove, China is willing to play the game.