Friday, December 25, 2015

The one-way renminbi bet?

It is now well-acknowledged that the fortunes of the world economy for the year ahead are more intimately tied to developments in China than elsewhere, including the US. Arguably one of the most keenly watched China-related news is that about its currency. In this context, Christopher Balding argues that the renminbi may be a one-way bet,
The market knows the RMB is going in one direction and they like those odds. Even if a hedge fund just shorts the CNY/CNH overnight with a not insignificant leverage and sells at trading open, recently, they would be making solid money... Chinese investors, retail and institutional, know that quality investment options in China are limited and are very interested in moving money elsewhere... If investors believe that the RMB is going lower, they will move more money out of China... the more the PBOC moves the RMB down, I see the pressure build on the RMB for additional weakening and additional pressure for rapid and violent movement. I see the incremental downward movement as adding incrementally to the probability of a sudden dislocation.
Given this strong incentive to short renminbi, the People's Bank of China's (PBoC) management of the currency over 2016 would be a test of its ability to play against global financial market participants. In this contest, it is likely that we end up seeing a few bouts of volatility in the value of renminbi, with its adverse consequences on the global financial markets as well as the competitiveness of other emerging market exporters.

But Beijing may have few other options left. As Balding writes, given the estimated 20-40% overvaluation of renminbi, any abrupt floatation would result in a sharp depreciation, with attendant adverse financial market consequences. It is, therefore, appropriate that on 11th December, the People's Bank of China (PBoC) announced that the currency would be denominated against a basket of currencies and not just the dollar. But this is also confirmation that Beijing prefers devaluation. Given the rising dollar and depreciating currencies elsewhere, this move would allow the renminbi to decline hopefully gradually against the dollar, thereby increasing China's export competitiveness without destabilizing other EM economies.

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