A renminbi devaluation: would it make sense?

Picture it: rumours of a renminbi devaluation keep growing. Residents rush to open accounts offshore as experts warn Beijing will get off on the wrong foot with a relatively new US administration if a big depreciation happens. Official denials are made regularly — until a devaluation of about 50 per cent follows in short order.

That was China in 1994. Today the idea of a similarly brutal, if smaller, one-off move is gaining some credence among strategists and traders as authorities battle to contain the exodus of capital as the renminbi weakens. Proponents, a group which includes advisers to Beijing, have suggested a 20 per cent devaluation would be sufficient.

The gradual decline in the renminbi may be more preferable for investors who recall the shock of the sharp depreciation of August 2015 but that has not stopped a relentless flow of capital out of the country.

The argument goes that a one-off devaluation would end the drip-feed pressure on outflows and reset the renminbi at a level viewed by the market as relatively cheap. Investors would feel more reassured about the renminbi valuation and, in theory, keep their money in the country.

There would, of course, be losers — “anybody with a renminbi exposure”, says Derek Halpenny at MUFG, such as Chinese companies and banks, which are burdened by dollar-denominated debts. “The price importers would have to pay would mean a squeeze in margins.”

If Chinese and international investors were convinced that a dramatic drop was genuinely a one-off, it could help staunch capital outflows. Further signs of pressure on the currency could come on Wednesday with the release of November figures of China’s reserves, which investors typically read as a proxy for intervention by Beijing.

After the dollar’s rise pulled reserves down by $47.5bn in October, the US currency’s sustained strength since the election suggests another big decline in the reserves is likely.

The consensus in FX is that dollar strength is here to stay for a while. Peter Kinsella, emerging markets strategist at Commerzbank, expects “more aggressive upside” in the dollar-renminbi rate in January and not just because of an appreciating US currency. The start of the new year is the moment when Chinese citizens can send up to $50,000 abroad.

For now there is a sense of calm given the small gap between the onshore and offshore renminbi rates. When this relationship widens, hitting a record 1,400 basis points in January, it is a signal that the market expects further depreciation.

Klaus Baader, head of Asia research at Société Générale, says if the logic of a one-off devaluation is based on the expectation that the renminbi is going to continue to steadily depreciate anyway, “then in theory — in theory! — trying to alter those expectations makes sense. I just don’t see it happening however.”

The risks are huge.

“The question is, what level do you get to before investors say ‘that’s enough’ and money stops flowing out? That’s really hard to determine,” says Mitul Kotecha, Asia head of FX and interest rate strategy at Barclays, who adds that he is increasingly hearing discussions on this idea.

”But what if you do 25 per cent and you’re still seeing outflows and it just results in a greater panic?”

Debate around the merits of such a bold move have sharpened as China has cracked down on people trying to take money out of the country. There is also tighter scrutiny of overseas investment and limits on renminbi remittances offshore.

And there is the noise across the Pacific as Donald Trump remains strident towards China. At the weekend, in a broadside against China, the president-elect tweeted: “Did China ask us if it was OK to devalue their currency (making it hard for our companies to compete) . . .?”

Any sign of a trade war would make it harder for China to move its currency. The next 12 months are tricky, not just because there is a new US president, but because the autumn sees a possible shake-up in the politburo at the 19th Chinese Communist party congress.

China has just achieved its longstanding goal of having the renminbi admitted to the International Monetary Fund’s reserve currency basket — hardly an opportune time for a sharp devaluation.

In 1994, China had little choice but to devalue as the gap between its official exchange rate and black market prices implied a depreciation of about 40 per cent was needed just to pull the two rates back into line.

Today, the offshore rate indicates a leaning among international investors towards further weakness, but it is slight. That leaves the decision in the hands of the People’s Bank of China. Few in the international markets think it is likely or even wise — but then, few outside China profess to have inside knowledge of Beijing’s thinking.