Easing Expectations of Renminbi Depreciation

In 2017, the renminbi displayed unanticipated strength against the US dollar. At the beginning of the year, most market analysts had expected the renminbi to continue its lengthy decline. Some analysts had even forecast the currency would weaken to seven to one dollar. However, the renminbi strengthened over the year, shaking off market pessimism at home and abroad. Since the beginning of September, although the US dollar rebounded, the renminbi managed to avoid any significant retreat.

The potential for depreciation remains a market concern, but so far the positive signs have been accumulating. There was a rapid decline in the deficit from foreign exchange purchases and settlements, and this has since shifted to a surplus. The stabilizing of the economy has also contributed to the improved market sentiment towards the currency. Meanwhile, the overall weakness in the US dollar has created a favorable external environment. Borrowers are no longer so eager to repay foreign debt, and this reflects the reduced expectations of a decline in the value of the renminbi. Nonetheless, the renminbi has not had a straight-line recovery; it has at times moved sideways in two-way trading.

If we examine the foreign exchange business conducted by banks on behalf of their customers -- generally a good gauge of market sentiment -- it can be seen that the renminbi underwent a period of depreciation followed by a rebound and then another depreciation phase in 2017. In the first quarter, the renminbi halted its decline against the US dollar and then rebounded. The deficit in bank payments and settlements fell to a low of US$7 billion in March. In the second quarter, the renminbi moved sideways and the deficit in bank purchases and settlements showed a further narrowing. In the third quarter, the renminbi appreciated against the US dollar and the deficit from foreign exchange purchases and settlements narrowed again, ultimately turning positive in September. As regulatory authorities gradually make their medium and long term policy stance apparent to the market, investor confidence in the renminbi rises and depreciation expectations dissipate.

Between January and August 2017 --  a period where there was a cumulative deficit in foreign exchange purchases and settlements -- the renminbi gained ground against the dollar, and this was partially a result of positive guidance from regulatory authorities. With a prolonged period of appreciation, there have been medium- and long-term policy signals from policy makers. Meanwhile, pressure from repayments of corporate foreign debt peaked at the end of 2016, and that has helped contribute to a renewed rise in the nation's foreign exchange reserves. Given these market developments, the pressure for depreciation of the currency has subsided.

In addition, speculative losses have helped dilute depreciation expectations. As the renminbi continued to strengthen over the January-August period, speculators holding large positions in US dollars in 2015 and 2016 faced lost income as US dollar interest rates were significantly lower than those on renminbi deposits. That meant that even though some market players were bearish towards the renminbi over the longer term, as long as the extent of depreciation did not offset the lost interest income, pressure to sell dollars would remain significant. That in turn helped trim the deficit in foreign exchange purchases and settlements.

While policy pronouncements on the exchange rate helped ease market concerns, the actual market trend played a more important role. With a deficit in foreign exchange settlements and purchases, as long as investors believed that regulators were wavering in their policy stance, the market's inclination to short the renminbi would increase. This explained the expectations of depreciation in the second quarter as players concluded that the rise in the first quarter was a temporary adjustment.

If we look at the renminbi's performance in 2015, we can see how past performance colors future expectations. That was clearly demonstrated after the August 2015 devaluation of the renminbi. From January to July in 2015, although there was heated discussion of the likelihood of depreciation of the Chinese currency, sentiment remained relatively stable. However, with the sudden renminbi devaluation in August that year, the view of the currency deteriorated immediately. The deficit from foreign exchange purchases and settlements that month climbed to US$128 billion, up 16% from the total January-July deficit.

It is noteworthy that despite the overall deficit in foreign exchange settlements, China’s foreign exchange reserves in 2017 recorded nine consecutive months of advances. The weakness of the US dollar led to the addition of non-US assets in the nation's foreign exchange reserve portfolio. But the gains from non-dollar assets would have been overwhelmed by a large deficit in foreign exchange purchases and settlements. The reduced expectations of a currency depreciation helped improve the reserve position. And certainly, the recovery of foreign exchange reserves in turn will play a positive role in reducing depreciation expectations in the future.

The easing of depreciation expectations in 2017 proved to be a gradual process. The timely guidance of regulatory authorities has been an indispensable factor in this new trading pattern for the nation's currency, providing a powerful deterrent to market overreactions. Investors are gradually adjusting to two-way movement for the renminbi, and that will mean continued reductions in expectations of a currency depreciation. China’s current account surplus will put upward pressure on the renminbi over the longer term. In the coming six to 12 months, even if the dollar index reaches 100 again, it is unlikely that the renminbi will weaken beyond seven to the US unit, and the renminbi is likely to trade in a range of 6.40 to 6.90.


The author is from CCB Financial Asset Investment Co., Ltd.