November 13,2009

PBOC Hints at More RMB Flexibility: Back to Appreciation?

By CSC staff, Shanghai

The People's Bank of China (PBoC), China's central bank, has just released its report on 3Q monetary policy implementation. Some unusual wording on renminbi (RMB) yuan exchange rate policy hints that China is about to repeal its "quasi-peg" to the US dollar and allow its currency more flexibility, another way of saying yuan appreciation.



The report mentioned that it will improve RMB's exchange regime. Prior to this, PBoC had emphasized the "stability" of RMB, worded as " keep(ing) the RMB exchange rate stable at a reasonable equilibrium level." That phrase does not appear in the new report.


The report states that in order to improve the exchange rate regime, the currency authority must "take into consideration international capital flows and the changes of the major currencies."


Analysts and PBOC watchers interpret this as meaning that monetary policy will soon shift gear in the direction of appreciation given wide and deep expectation that RMB will strengthen against a weakening USD.


Since September, 2008, the RMB/USD exchange rate has been virtually frozen by China's monetary authority to handle the financial crisis, just as China did in 1997-98 during the Asian Financial Crisis.


RMB's USD peg has been the cause of troubles, increasing economic imbalances and bringing down international displeasure. 


USD depreciation and hot money inflows are now causing great concern to Beijing officials. In September, financial institutions had to issue 406.8 billion yuan above August totals to buy foreign currencies, the highest in 2009, and much more than the amount used to buy foreign currencies from trade surplus and foreign direct investment inflow. The widening gap indicates that hot money inflow is accelerating. From January to August, the monthly increase of foreign currency generated amounted to 100 billion to 200 billion yuan.


PBOC Governor Zhou Xiaochuan said in a recent speech to the 15th anniversary dinner of the China and Europe International Business School that fine tuning monetary policy would include the end of the razor-thin fluctuation band of RMB/USD exchange rate. According to Zhou, "this time" in dealing with the financial crisis "we did the same as we did during Asian Financial Crisis in 1997, narrowing the band in order to prevent yuan depreciation. This is unusual during crisis." He added that when the economy returns to a new equilibrium, a more flexible yuan exchange rate may be part of an exit strategy.


Ha Jiming, chief economist for China International Capital Corporation, expects RMB to appreciate 3% to 5% in 2010. In particular, he suggested that in the first quarter of 2010, China will be pressured by its trade partners to allow appreciation since its exports will be close to full recovery and money supply in 2010 will rely on capital inflow and bank credits.


Once currency appreciation is widely accepted, it could catalyze a market surge, especially in the real estate and stock markets. On July 22, 2005, a sudden appreciation of 2% caused an A-share market jump the following day.


PBoC is also concerned about the build up of inflationary pressure and asset bubbles. As the CPI is turning from negative to positive, such pressures will increase. In 2010, the central bank may use tools such as credit quotation, increasing reserves and even interest rate hikes to limit asset froth. 

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