The renminbi’s recent strength is slowing China down. But it is the clearest signal yet that the country is serious about reforming its economy
Currency warriors have little time to rest. Having spent the last few years lobbying for weaker currencies, emerging markets are now under the gun to boost them: since the Fed talked about rolling back its bond buying program last spring, many currencies have been hovering close to multi-year lows. This has prompted Brazil, Turkey and Indonesia, among others, to tighten liquidity last month. With $12.5bn in short-term capital retreating from developing nations since May, more countries are likely to follow.
One usual belligerent has so far remained on the sidelines, however. Having gained nearly 2 per cent against the US dollar in the five months to June, the Chinese renminbi has remained remarkably stable since then – even posting successive all-time highs last week. Its performance is all the more impressive when compared to other currencies: according to the Bank of International Settlements, China’s trade-weighted exchange rate has risen 12.7 per cent since 2010, faster than that of any of the 60 other economies it tracks.
This long-term appreciation reflects deep historical forces, such as China’s rapid economic growth, vast dollar reserves and strengthening labour laws. But the redback’s recent performance has probably more proximate causes. China’s interest rates remain several basis points higher than in most major economies; devaluation fears, which had arisen last year in anticipation of a tricky leadership change, have now largely vanished. This has lured short-term capital back in the country, thereby supporting the currency.
There is another side to the story, however. The renminbi remains a managed currency: it is only allowed to trade within a narrow band against a reference rate defined daily by the central bank. At a time when sagging exports and a slowing current account surplus are weighting on China’s economy, Beijing would have every incentive to guide down the renminbi. And yet the central bank has done little to curb its strength, moving the daily reference rate to accommodate the currency’s movements.
This is a strong signal that China’s new leaders are committed to pushing ahead with wider economic reforms. Last May, the government announced plans to unveil a roadmap for easing capital controls by year-end; having the renminbi close to market value makes it less likely that this will trigger a destabilising inflow of foreign money. It also makes net exports a lesser contributor to GDP growth, helping China rebalance its economy towards domestic consumption.
What China really wants, eventually, is for the renminbi to become a reserve currency. This is likely to be a long battle: the liberalisation of interest rates, a precondition to the redback’s full convertibility, is still in its infancy. But Beijing’s recent shift in monetary stance is nonetheless a good start. As it ponders its next offensive – on this front as on the others – China is right to make peace with a stronger renminbi.
Photo Credit: Titan Noble