Macroeconomy

A more market-driven renminbi

Policy moves in October lead us to believe that China’s central bank has more wide-ranging plans for the renminbi beyond keeping it relatively stable.

Luc Luyet & Dong Chen

A more market-driven renminbi

On 21 October, China announced that it would start issuing USD10bn worth of new Qualified Domestic Institutional Investor (QDII) quotas, allowing more domestic institutional investors to invest abroad. Furthermore, on 27 October, the People’s Bank of China (PBoC) instructed banks to remove the counter-cyclical adjustment factor (CCAF) used in quoting the daily fixing price of the RMB. By removing the CCAF, the PBoC effectively is giving up one of the most powerful tools at its disposal to control the currency and ensuring the RMB’s behaviour going forward will be much more market driven.

Overall, we see the PBoC’s recent actions as a move toward a more market-driven exchange-rate regime, in line with the Chinese government’s intention to prioritise the domestic economy and paving the way for further internationalisation of the currency.

A window of opportunity has opened for RMB exchange-rate reforms. Expanding by 0.7% year-over-year in the first three quarters in 2020, China is the only major economy in the world that is expected to achieve positive growth this year. Furthermore, contrary to other major central banks still firmly in super-easing mode, the PBoC has already normalised its monetary policy, making Chinese government bond yields particularly attractive compared to peers’.

With less central bank intervention, the RMB exchange rate could become more volatile. However, with superior growth and interest rate differentials, we think that the RMB is well positioned to withstand such volatility, especially if our scenario of a weaker US dollar proves to be correct. Strong current account dynamics should remain supportive of the currency for at least the next six months, while further liberalisation of the Chinese financial market may lead to reserve managers increasing their allocation to the Chinese currency.

The RMB could consolidate in the short term covid concerns rise globally, favouring the safe-haven US dollar. Consequently, we see little reason to change our three-month forecast of CNY6.80 per USD. At the same time, strong fundamentals and increased flexibility suggest that our current 12-month estimate of CNY6.50 per USD may be too conservative. We will wait for the US elections before changing our 12-month projections, but we are inclined to be more positive on the RMB than we are presently.

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