China tries to rein in Renminbi again

  • Renminbi has appreciated versus the US Dollar by over 12% in the last year and by 2.8% since the start of 2021
  • FX rate export competitiveness gain versus China in last year for Korea-Taiwan hardware and Bangladesh-Vietnam garments
  • FX rate competitiveness versus China has improved most for Bangladesh, India, Pakistan, Sri Lanka in the last 5 years
China tries to rein in Renminbi again

The China Renminbi (CNY) has appreciated versus the US Dollar by 12.2% in the last year, 2.6% year-to-date, and 1.7% in the last month alone. The Chinese authorities appear to be shifting from rhetoric from sources associated with the central bank (PBOC) to active measures, such as the increase in the reserve ratio on foreign currency holdings by financial institutions (from 5% to 7%). Nevertheless, the drivers of CNY appreciation are likely to persist in our view until, at a minimum, there is a turn in the US interest rate cycle.

Still, it is worth mentioning, on a longer-term perspective, that the moves in CNY versus the US Dollar do not appear that dramatic, eg merely 3.3% higher on a 5-year view. The CNY real effective exchange rate is also within a percentage point of its 5-year median value (eg 127 versus 126, according to BIS estimates).

As important for investors in Asia emerging markets as CNY moves versus the US Dollar is the CNY moves versus other Asian currencies. On a 5-year view, the currency competitiveness of China's potential exporter rivals in South Asia (Bangladesh, India, Pakistan, Sri Lanka) has substantially improved (by 10 to 35 percentage points) and this relative gain is unlikely to reverse, regardless of the trajectory of US interest rates.

China Renminbi 12% stronger versus US Dollar in last year

Drivers of CNY appreciation vs US$ likely persist

CNY strength versus US Dollar has been driven by the factors listed below, most of which likely persist.

  • Expectations of faster growth in China than in the US (eg 8.4% and 5.6% in 2021 and 2022 in China versus 6.4% and 3.5% in the US, according to IMF forecasts).

  • Portfolio inflows to China (driven by 3.1% local currency 10-year bond yield compared with 1.6% for US 10-year and a 3.0% real interest rate).

  • Ongoing looser US monetary policy and the prospect of further US fiscal expansion.

  • Less "flight to safety" appetite for the US Dollar (albeit there remains no short-term threat to its status as the dominant reserve currency).

  • Fewer outbound Chinese tourists during Covid-19 and a continuing current account surplus (1.6% and 1.3% in 2021 and 2022, according to IMF forecasts).

While CNY appreciation erodes export competitiveness, it also encourages consumption imports at a time when the authorities prefer a shift from an export to a consumption-based economy (the "dual circulation" economic strategy).

Implications for Asia EM equity investors

China-HK is the largest weight in the MSCI EM index (c38%). The next two largest are also two of its main competitors in Technology Hardware exports – Taiwan and Korea (each about 13% of the index). While China's FX rate has appreciated significantly year-to-date, so have those in Taiwan and Korea.

However, the FX rate in India (10% of MSCI EM) is up about 4% year-to-date; equating to an 8 percentage point gain in competitiveness versus China compared to the start of the year, all other factors being equal. A number of smaller Asia exporters have also seen competitiveness gains, eg c11-12 percentage point gains for Bangladesh (garments) and Vietnam (Tech Hardware and Garments).

Export competitiveness gains versus China for Asian export rivals over the last year, although less so for Korea-Taiwan

On a 5-year view the picture on FX rate competitiveness across Asia is mixed with substantially better FX rate competitiveness for South Asia (Bangladesh, India, Pakistan, Sri Lanka) versus China, but substantially worse competitiveness for South Korea and Taiwan versus China. FX rate competitiveness is one in a range of drivers for the shift of marginal manufacturing capacity away from China.

Over 5 years, big export competitiveness gains versus China for Bangladesh, India, Pakistan, Sri Lanka but big deterioration for Korea, Taiwan, Thailand

Related reading

US Dollar's reserve currency status is fading, but it's still dominant, May 2021

China Renminbi strength means competitiveness gain for India and smaller Asia EM, November 2020

China tries to restrain Renminbi but drivers of strength persist, October 2020

US Dollar: Recent weakness, drivers up and down from here, July 2020

China manufacturing is irreplaceable but India and other Asians can win share, June 2020

For a quantitative analysis of the China Renminbi, please see this report from James Huckle: Chinese yuan breaks 3-year high against the dollar, May 2021


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