Treasury Today Country Profiles in association with Citi

Is RMB appreciation coming to an end?

Murmurings by Chinese officials suggest that the appreciation of the national currency may be about to grind to a halt.

Seven years ago, China adopted a managed floating exchange rate regime. That is to say, the price of the RMB was fixed by the People’s Bank (PBoC) against a basket of currencies that included the US dollar, the euro and sterling. Each day, the central bank fixes the exchange rate – the mid-price – which the market takes as the starting point for that day’s trading. Initially, the redback was allowed to float within +/-0.3% of the price set by the central bank. Today the band stands at +/-0.5 against the USD and +/-0.3% against non-USD currencies.

J.P. Morgan chart depicting the RMB exchange rate

Source: J.P. Morgan

This has allowed the currency to strengthen to its current level of around 1 US to 6.3 yuan. Communist party officials have intimated that CNY appreciation may be about to slow, however. Premier Wen Jiabao said the Chinese currency was close to its ‘equilibrium value’, having risen in value by 30% since it was semi floated in 2005. Mr Jiabao pointed to the recent volatility in the market for non-deliverable forwards (NDFs) – which has started to move in both directions of late – as evidence that the value of the currency has started to level off.

“Overall we think that CNY is now much closer to its equilibrium value. There is still room for appreciation in the coming years,” says a recent report by J.P. Morgan China. “We expect CNY appreciation to be around 3% this year and next, but for the pace to slow markedly after that. A strong and stable currency remains an ultimate strategic interest for China, and an important part of its effort to shift the source of growth from exports toward domestic demand. As the PBOC noted, the objective of the exchange rate regime is to achieve a general external balance. From this perspective, the most important indicator is the current account balance.” In 2011, the country’s current account surplus stood at 2.8% of GDP in 2011, down from 5.1% in 2010.

One consequence of the slowing pace of RMB appreciation is likely to be felt in the off-shore dim sum bond market, where investors have snapped up corporate debt at low yields and held to maturity in the expectation that the mainland’s currency will have appreciated considerably over the duration of the bond. As the appreciation of the currency tails off, this may be about to change.

Indeed, analysts expect to see the secondary market in dim sum bonds become increasingly active and bond yields more faithfully reflect the underlying creditworthiness of the issuer as investors look more at interest rates and less at currency appreciation.