Currencies: A Modest Rise in the Risk of China Not Moving in 2005
Stephen L. Jen (London)
I have been looking for Beijing to start to dismantle its de facto dollar peg sometime this year. While I still think Beijing will likely move on the RMB later this year, recent developments suggest that the probability of a controlled RMB float this year has declined somewhat. We think investors would still be well advised to have a core short USD/AXJ position, but they should now consider the prospects of the AXJ currencies on their own merits rather than using them as a proxy for a prospective RMB float.
Our call on the RMB. There are several facets to our call on the RMB. In principle, Beijing fully supports the view that greater currency flexibility is good for China. I have long reminded investors and policymakers that former People’s Bank of China Governor Dai Xianglong announced, as early as 2001, China’s support of greater currency flexibility. It was not until later, when the USD began to weaken, that foreign policymakers and commentators started to “urge” Beijing to make the RMB more flexible. There should thus be no doubt that China has the same objective as everyone else regarding the RMB. The remaining issues have been the form of the new RMB regime, the timing, and “sequencing.”
First, regarding what type of new RMB regime Beijing is likely to adopt, I still firmly believe that the most likely scenario is a move from the current de facto USD peg to a controlled float within a wide corridor centred on a basket reference rate. A one-off large revaluation from the current parity of 8.28 to a lower number is extremely unlikely. So is an outright move to a clean float.
Second, in terms of timing, over the past two years, my call has shifted once. From 2003 to November 2004, I called for the RMB to be moved to a controlled float in the second half of 2005. In November 2004, however, I thought that the pressures were mounting for a possible move in 1H05.
Third, in terms of “sequencing,” I have always believed that Beijing would first satisfy itself with progress on reforming the banking industry, liberalising capital outflows, and nurturing a more market-based interest rate market. All of these are still prerequisites to any change in the RMB regime, in my view.
The marginal changes in my view on the RMB. While I still think we cannot rule out a change in 1H05, I now think that the latter part of 2005 is more probable, and that there is rising risk that Beijing may not do anything regarding the RMB this year. Here are several reasons behind this tweak:
· The State Council may have put the whole thing on the back burner for now. In trying to track the status of the RMB discussion in Beijing, one should recognise that while there has been a genuine debate between different groups of policymakers and scholars over the best course of action, the urgings of some technocrats may not reflect the views of the true decision makers in Beijing. In any case, I suspect that in recent months an explicit proposal may have been submitted to the State Council, but the State Council may have decided to put the whole issue on the back burner. Premier Wen Jiabao may have decided that with the economy still struggling to land softly, now may not be the best time to introduce such a major policy shift. In addition, as far as Beijing is concerned, the issue of the RMB may not be linked to only economic considerations. Beijing may be waiting for opportunities to exchange a policy shift on the RMB for “something,” e.g., Taiwan or trade status. Until that something becomes clear and negotiable, the RMB issue will likely remain on the back burner. Third, the general market sentiment on the USD may still be too bearish for Beijing to move. The familiar concern here is that if China allowed a modest appreciation, more speculative capital could be drawn in. Thus, the safer strategy could be to wait until the USD finds better footing.
· Inflationary pressures are abating, and the focus on growth is shifting. Outside China, one of the key arguments in favour of a large RMB revaluation or an early float is that “it would be good for China.” The specific argument is that it would help China contain inflationary pressures. One problem with this argument is that inflationary pressures (both CPI and PPI) have abated in recent months. My understanding is that the government in Beijing is less concerned about the headline growth rate or the inflation rate and more concerned about the widening income disparity among regions/provinces. Whether the top policymakers focus on headline growth or growth disparity is very important because, ideologically, currency appreciation helps those who already have money but hurts those who indirectly rely on the export sector to make a living.
· Sequencing is key. In recent months, there has also been a greater focus on “sequencing”; i.e., what needs to be done before China can move away from the current RMB regime. There are three broad areas where work can still be done to better prepare China for a new currency regime. First, commercial banks must continue with reforms. Second, capital outflows can be further liberalised. Third, more foreign exchange products need to be introduced. |
