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The renminbi: not as weak as you think

The renminbi’s seemingly endless grind lower against the US dollar has been one of the financial stories of 2016, triggering a wave of capital outflows from China that Goldman Sachs estimates may have totalled $1.1tn since August 2015.

The once closely controlled Chinese currency has tumbled 6.5 per cent to an eight-year low of Rmb6.945 against the greenback this year, taking its slide since August 2015 to 10.6 per cent.

As increasingly panicky Chinese and foreign entities have sought to evade the ongoing devaluation of their renminbi holdings by getting money out of the country, capital outflows have surged, with estimates of their size ranging from the $520bn that the Institute of International Finance believes was spirited out of China in the first 10 months of 2016 to Goldman’s $1.1tn figure.

Yet, arguably, there is another interpretation of what is happening to the currency of the world’s second-largest economy, one which may help allay some of the panic.

Since the end of June, the renminbi has been remarkably stable against the trade-weighted basket of 13 currencies introduced by the People’s Bank of China in December 2015.

Having closed at an index level of 95.02 on June 30, the renminbi has oscillated in a range of 93.78 to 95.34, according to the weekly updates released by the China Foreign Exchange Trade System, an arm of the People’s Bank. The most recent figure, for December 16, shows a reading of 94.99, just 0.03 points below that of June 30.

“Although there has been a lot of talk about crisis or big problems against the dollar, [the renminbi] has held very stable in basket terms since early July,” says Robert Minikin, head of Asia FX strategy at Standard Chartered.

That this has been little noticed is largely because of the market’s (and indeed the media’s) almost total obsession with the renminbi’s bilateral rate against the dollar.

Yet Zhou Xiaochuan, the governor of the People’s Bank, said in February that keeping the renminbi “at a broadly stable level” against the basket, would be the “keynote” of the bank’s new exchange rate regime.

Admittedly, Mr Zhou’s argument was somewhat undermined by the behaviour of the renminbi in the first half of 2016, when it fell 5.9 per cent against the basket, before finding stability in the second half.

As a result, the currency has fallen almost as much against the basket as against the dollar this year, although the shape of the slide has differed sharply, with the renminbi’s 2.1 per cent fall against the greenback in the first six months of the year accelerating to a 4.5 per cent slide in the second half, as the first chart shows.

But might something important have changed midyear? Might the People’s Bank now be using its formidable currency intervention to achieve the target Mr Zhou outlined in February? Mr Minikin thinks so.

His argument is that the basket has been king since its introduction in December 2015 but that the renminbi’s starting level against the basket was problematic, given the currency’s “powerful upswing” in trade-weighted terms between the middle of 2014 and August 2015. (Over the longer term it rose more sharply still, as the second chart, based on an index drawn up by the Bank for International Settlements, indicates).

During the first half of 2016, the People’s Bank “took back roughly half of that overvaluation”, he says, allowing the currency to drift back towards a “truer” level.

“All along they were assessing the value of the currency on a trade-weighted basis, but at the beginning of this year the starting point was not a very good level to lock in because they were locking in the revaluation of 2015,” Mr Minikin says.

However, with the trade-weighted renminbi seemingly reaching a level that the People’s Bank was comfortable with by the end of June, since then “the authorities are doing exactly what they said they would do and pretty much what we think they should do”, he adds.

Not everyone shares this interpretation of events, however. Mark Williams, chief Asia economist at Capital Economics, says “there are two ways” of reading the situation, with one being that “since the middle of the year the People’s Bank has more formally adopted a peg against the basket”.

“I don’t think that’s right,” Mr Williams says, however. Instead, he believes the stability against the basket is more the result of the resurgence of the dollar, which fell on a trade-weighted basis in the first half of the year, before rallying in the second half.

Because of this, any continued renminbi depreciation against the basket in the second half would have led to a sharper fall still against the greenback.

“If they had allowed weakness against the basket that would have led to more concerns about what is happening to the renminbi and more capital outflows,” Mr Williams says.

Instead, he argues that the People’s Bank has engaged in “opportunistic devaluation against the basket”.

In other words, when the dollar was falling, the PBoC felt able to let the renminbi weaken against the basket, but when the dollar rose, the central bank instead kept the renminbi stable against the basket, in order to minimise its decline against the resurgent greenback.

Indeed, since November 8, when Donald Trump’s unexpected victory in the US presidential election set off a powerful dollar rally, the renminbi has strengthened in trade-weighted terms.

“You end up with these stop-start moves against the basket and the dollar,” says Mr Williams. “The issue is that, try as they might, the People’s Bank can’t get financial markets to focus on the basket.”

Win Thin, global head of emerging market currency strategy at Brown Brothers Harriman, believes the renminbi’s steadiness against the basket since the end of June is little more than a reflection of Beijing’s desire for “some measure of stability”.

“The last thing they want is uncontrolled capital outflows. It’s not just China, we have seen outflows from most of the emerging markets,” he says.

Despite this, Mr Thin says few people he comes across focus on the rate against the basket. “We look at the bilateral rate for our clients. Investors, politicians, everyone is still pretty much fixated on the dollar rate,” he says.

Mr Minikin says an increased focus on the basket would help reassure people that China is not heading for the rocks.

“Over time, as market participants and corporates become more attuned to the new regime, people will realise that there isn’t any big China crisis or devaluation out there, so this will allow confidence to be restored,” he says.

Nevertheless, even StanChart’s Mr Minikin does see scope for turbulence ahead. His 2013 book The Offshore Renminbi: The Rise of the Chinese Currency and Its Global Future, outlined the turbulence faced by the Australian dollar when that currency was internationalised in the 1980s.

With Beijing now committed to allowing the renminbi to follow suit, he believes a few more bumps in the road may be inevitable.

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