Get more with myNEWS
A personalised news feed of stories that matter to you
Learn more
No pain, no gain

Renminbi's volatility simply growing pains of emerging international role

Dan Steinbock says fluctuations in the Chinese currency is not a sign of long-term weakness but part of the growing pains it must endure as its importance develops in international finance


The recent volatility of the renminbi does not herald its weakening, but the increasing opening of the currency and still another milestone in its international ascent.

After a sharp depreciation in China's currency since the beginning of this year, the United States, early this month, warned Beijing not to manipulate it , ahead of IMF, World Bank and G20 meetings to be held in Washington.

In turn, International Monetary Fund managing director Christine Lagarde warned of a risk of a "hard landing" in China, which led to a prickly debate with China's deputy finance minister, Zhu Guangyao . After these meetings, the US Treasury slammed Beijing even harder on currency.

Ironically, as Beijing has initiated the most extensive and deepest reforms in three decades, it finds itself penalised, not rewarded, in the West.

In reality, the renminbi's volatility did not come out of the blue; nor was it the result of simple market forces. In part, it was engineered in Beijing - but as an integral part of the reforms, not against these reforms.

In the past two decades, the euro and, to a lesser degree, the Japanese yen have become important regionally. However, neither has been able to challenge the US dollar's dominance globally.

Although the renminbi is positioned to become a major reserve currency, that requires capital account convertibility, which is vital in international trade and finance. Furthermore, in the past quarter, international observers have expressed concern over the weakening of the renminbi, currency wars in Asia and trade conflict with America. The realities are a bit different, however.

Ever since Washington stumbled into its debt crisis in August 2011, China has felt increasing unease with the symbiotic relationship that prevails between the renminbi and the dollar. When Washington was swept by still another debt crisis and government shutdown last October, Chinese concerns increased accordingly, due to Beijing's stakes in US debt and dollar-denominated assets and reserves.

A month later - after the Communist Party's third plenum, which codified the huge reform agenda of China's new leadership - the priorities shifted at the State Administration of Foreign Exchange. Led by People's Bank of China deputy governor, Yi Gang , its new priority was to curb the growth of foreign reserves and to make them work more efficiently as investments. That's when Beijing's focus shifted from the appreciation of the renminbi towards building a market- driven rate-adjustment system that is flexible and requires less central bank intervention.

That's also when China's holdings of US Treasury securities began to decrease.

Between 2010 through last year - at the peak of rounds of quantitative easing in the US, which encouraged massive amounts of foreign capital into China and other emerging markets - the Chinese yuan per US dollar decreased from 6.80 to less than 6.10. In mid-February came the currency's six-day losing streak, which reflected the fastest yuan correction in two decades.

With hot money fleeing from vulnerable emerging markets, massive capital inflows were washing over mainland China. The renminbi seemed a one-way-bet, a currency that would only appreciate. The PBOC wanted to defuse the role of the speculators. So in mid-January, the PBOC began to set weaker fixings, which undermined the assumption of ever-continuing appreciation (the yuan peaked at 6.23 on March 20).

Then came March 15, when the PBOC widened the daily trading band for US dollar and Chinese yuan, doubling it to +/-2 per cent - another milestone in Beijing's quest for capital account convertibility.

The old era of central bank intervention, lower volatility and exclusively appreciating renminbi is now fading out. In the new era, the PBOC's interventions are decreasing, and the renminbi can move more freely. While the fundamental trend is towards gradual appreciation, increasing volatility comes with the new territory.

As Beijing took another step closer to the renminbi internationalisation and its ultimate role as a major multipolar reserve currency, it has diversified risk and boosted capital efficiency. Meanwhile, its foreign exchange reserves have grown to US$3.95 trillion, according to most recent data.

China's role among the major foreign holders of US Treasury securities peaked at US$1.32 trillion in November last year, when the priorities were redefined at the State Administration of Foreign Exchange. It declined to US$1.27 trillion by February.

Reportedly, some 40 central banks have already invested in the renminbi and others are following. The launch of direct share-dealing between Shanghai and Hong Kong within six months is still another milestone in the same dynamic process.

Intriguingly, the Chinese currency is seemingly on its way to reserve status, even before full convertibility. In part, that reflects its increasing attractiveness. In part, it heralds the growing unease with the US dollar.

After the second world war, America was the world's greatest creditor, accounting for almost half of the world economy. Today, it is the world's greatest debtor, accounting about a fifth of the global economy. And yet, the US dollar remains the primary world currency. In the long run, that's not just an "exorbitant privilege" but unsustainable.

The lesson to investors? Do not mistake short-term fluctuations (the renminbi's recent volatility) with long-term structural trends (the economic rise of China and the long-term appreciation of the yuan).

We are not witnessing the ultimate end or triumph of the Chinese currency. The volatility of the past quarter heralds the growing pains of the renminbi.

This article appeared in the South China Morning Post print edition as: No pain, no gain