China Will Intervene To Slow RMB Appreciation Until 2014

The author is Capital Economics’ China economist Qinwei Wang

China’s stock market rebounded strongly in the second half of November, as the
comprehensive reform plan released following the Plenum seems to have eased fears
of a sharp slowdown in the economy.

Meanwhile, the People’s Bank of China has kept the onshore RMB exchange rate stable, despite its talk of ending regular currency intervention causing the offshore RMB to strengthen.

This month, China’s stocks have outperformed most other Emerging Asian equity
markets, which have suffered renewed volatility caused by a return of concerns over Fed tapering.

The Shanghai Composite has rebounded by 5.7% over the last two weeks, reversing
losses that started in late October. This reflects a marked recovery in investor
sentiment about the medium-term outlook for the economy.

The detailed plan released after the Plenum showed stronger determination among China’s leadership for structural reforms, which are necessary to avoid a sharp slowdown in the economy.

Foreigners need official approval to invest in China’s equity markets, and their impact on the Shanghai Composite is small. So far, the overall value of approved overseas funds is less than 2% of total market capitalization.

However, foreign investors can freely invest in stocks of Chinese firms listed in Hong Kong. These have risen by around 11% since mid-November, nearly double the rise of their mainland-listed counterparts.

This has helped the Hang Seng to gain by 2.3% this month so far, outperforming most in the region.

Meanwhile, monetary conditions have tightened further. While interbank rates have
been volatile, their average this month is on course to be the highest since January 2012, barring the cash crunch in June.

Policymakers look likely to maintain a tight stance. This week, the Governor of the People’s Bank (PBoC), Zhou Xiaochuan, said that the economy must rely on reform and not on loose monetary or fiscal policy to sustain growth.

The growing belief that monetary conditions will remain tight for some time looks to be the major cause of the recent surge in onshore government bond yields and, more generally, firms’ financing costs.

In addition, growing expectations that China will fully liberalize interest rates within a few years’ time has been an added factor in pushing up long-term yields, which had, until recently, remained broadly stable since the financial crisis.

The PBoC has also pledged to end its regular interventions in foreign exchange markets, leading to renewed speculation of RMB appreciation. Ironically, although there was a marked gain in the offshore RMB exchange rate, the onshore RMB has been fairly stable.

This likely means that the PBoC has continued its net purchases of foreign exchange to prevent the RMB from appreciating. Indeed, early indicators suggest that net foreign exchange purchases by the PBoC continued to rise last month.

The gap between the offshore and onshore RMB exchange rates was never likely to
last long, given the ability of firms with cross-border trade operations to arbitrage the difference. Indeed, it has already almost disappeared.

We continue to think that the PBoC will still intervene heavily to slow currency
appreciation, and the RMB will probably reach RMB6.00 per U.S. dollar by end of 2014.

If we are correct, significant capital account liberalization, among the reforms proposed at the Plenum, is unlikely to happen in the near term, as a flexible exchange rate is generally seen as a necessary precursor.

Finally, the Hong Kong dollar has strengthened slightly over the last few months,
approaching a level close to the strong side of its band.

(The article has been edited for clarity)

China Expert network



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