China: A “Strong RMB” Strategy

Published on February 11, 2016
SGH Insight
"We have learned that on President Xi Jinping's instructions, four departments led by the People's Bank of China presented a joint policy document entitled "China's Strong RMB Strategy" to the State Council and the Central Financial Leading Group, in which a five to fifteen year currency plan will target a gradual appreciation of the RMB against the basket of 13 currencies and for the RMB/US dollar exchange rate to be held within a relatively tight range in the near term."
Market Validation
(Bloomberg 2/15/16) -- "China’s yuan surged by the most in more than a decade, catching up with dollar declines during a week-long holiday, after the central bank chief voiced support for the exchange rate and set its fixing at a one-month high. The currency advanced 0.9 percent, the most since the nation scrapped a peg to the dollar in July 2005, to 6.5170 a dollar as of 10:50AM in Shanghai, according to data compiled by Bloomberg. The offshore yuan fell 0.16 percent to 6.5186 to almost match the onshore rate, compared with a 1 percent premium last week when mainland Chinese markets were shut for the Lunar New Year holidays."

Arguments over just how violently China will be forced to – or decide to – devalue the Renminbi have turned almost into a parlor game among some traders and investors, with large bets on that outcome.

 

But the wilder of those predictions betray a lack of understanding of the strategy of China’s leadership, their determination to pursue those goals, and indeed what are in fact enormous concerns over continued excess volatility, outflows, regional, political, and financial instability that a severe depreciation would exacerbate, if anything, for any benefits that may or may not accrue from it on the trade side.

 

*** Indeed we have learned that on President Xi Jinping’s instructions, four departments led by the People’s Bank of China presented a joint policy document entitled “China’s Strong RMB Strategy” to the State Council and the Central Financial Leading Group, in which a five to fifteen year currency plan will target a gradual appreciation of the RMB against the basket of 13 currencies and for the RMB/US dollar exchange rate to be held within a relatively tight range in the near term. ***

 

*** In order to help underpin the strong RMB strategy over the policy horizon, China will, along with intervention and other measures, increasingly invoice crude oil purchases in the RMB instead of US dollars. China has already used RMB to purchase crude oil from Russia and Iran, paying for part of total payments in 2015 in RMB. China is also committed to fully implementing the free convertibility of the RMB during the current 13th five year period that began this year. ***

 

“China’s Strong RMB Strategy” – Key Summary

 

The historical backdrop stated to the strong RMB strategy is the Chinese belief that a necessary condition for the US and the European Union to have become great powers is a strong currency. The Strong RMB strategy is consistent with the long-term goals of China’s development.

 

Over the next five years and even the next fifteen years, Beijing will therefore undertake policies to ensure a gradual and orderly market-oriented appreciation of the RMB against a basket of currencies. By 2020, China’s GDP will be slightly behind the US’s. By 2030, China’s GDP will be $3-5 trillion bigger than that of the US. It has been determined that the RMB will continue to go up gradually and in an orderly fashion rather than fall over the next fifteen years.

 

It is feasible to let the RMB vs. the USD remain in a range between 6.3000 and 6.7000 over the next two years (2016-2017). That is also in line with the status quo of China’s economic development. If China’s economic growth does not meet expectations (actual GDP at 6.7%), or if the US were to raise interest rates three times this year, the RMB vs. USD could drop to 6.7000 or so on the onshore market this year.

 

In the period from 2020 to 2030, a reasonable range of the RMB against the USD is between 5.000 and 6.000.

 

Indeed, Chinese officials caution in the report that the strong RMB policy will not necessarily mean the RMB will remain strong against the USD throughout the projected policy horizon. The US economy is entering an uptrend while China’s economy is in a period of restructuring, allowing RMB vs. USD to depreciate in a fashion relatively in line with the current status of China’s economic development as well as in line with China’s long-term economic development goals.

 

Among other points made by the working group on policies to ensure a strong RMB:

 

– A strong RMB means the PBoC will intervene as necessary when the RMB falls into turmoil. In the current bearish atmosphere on the RMB and the HKD, Chinese officials believe foreign speculators have been building large-scale positions to short the RMB and the HKD on an unprecedented scale. So, the PBoC and the Hong Kong Monetary Authority must work closely together to take a number of counter-measures to support the two currencies. China’s actions must let speculators feel that they will lose instead of gain from shorting the two currencies.

 

– A strong RMB means that the RMB against a basket of currencies will be kept on a stable and gradual appreciation trend over the next fifteen years. As long as the RMB against a basket of currencies remains stable, China can achieve the goal of becoming the largest and most powerful economic body in the world.

 

– A strong RMB and its inclusion in the International Monetary Fund’s SDR basket means that most foreign central banks will hold the RMB in their FX reserves and use the RMB to deal with their economic affairs. By the end of 2015, 38 central banks in the world held RMB as FX reserves assets. And a strong RMB also means that the RMB’s weight will increase in the IMF’s SDR basket. By 2020, the RMB is expected to have a 15-16 percent weight in the SDR basket from the current 10.92 percent.

 

– A strong RMB means that PBoC will continue to sign more currency swap agreements with foreign central banks. By 2015, the PBoC had signed currency swap agreements with 33 countries with a total value hitting 3.3 trillion yuan.

 

– A strong RMB means China will increasingly invoice crude oil purchases in the RMB instead of US dollars. China has already used RMB to purchase crude oil from Russia and Iran, paying for part of total payments in 2015 in RMB. China is also committed to fully implementing the free convertibility of the RMB during the current 13th five year period that began this year.

Back to list