Chi on China RMB Undervaluation, Déjà vu

Transcription

1 For professional investors 26 February Chi on China RMB Undervaluation, Déjà vu SUMMARY The fall in China s current account surplus in recent years has not resulted from a genuine change in the underlying trade structure, but from a negative terms-of-trade shock of the increase in global commodity prices between 2002 and Commodity price weakness will likely reverse this effect. China s current account surplus may grow again, aggravating the undervaluation of the RMB (under a closed capital account) and putting Beijing in an awkward foreign exchange policy position. International pressure for a revaluation of the RMB will return and the currency s volatility will rise. To mitigate these pressures, Beijing could widen the RMB trading band. Higher foreign exchange risk should also facilitate the RMB s internationalisation by prompting more trade settlement in the currency. The consensus forecast for China s current account surplus, for example as seen in Bloomberg s survey, ranges between 2.3% and 2.5% this year and next. This may have to be revised up soon. Available data already suggests that China s current account surplus might have risen to more than 2.6% in 2013 after hitting a low of 1.9% in 2011 and 2.3% in Meanwhile, the RMB-USD exchange rate rose by an average of 1.9% YoY in 2013, almost equal to our forecast of 2.0%, and the nominal effective exchange rate (NEER) rose by 5.7%. Current account, an elusive indicator Under a closed capital account, China s shrinking current account surplus (Chart 1) is a visible sign of a correction of the RMB s undervaluation. The same narrowing trend has been seen in its basic balance surplus, a broad measure of the external accounts calculated by adding long-term capital inflows (as approximated by net foreign direct investment, FDI) to the current account. A declining trend in the external balances has been the key argument for the RMB exchange rate approaching equilibrium.

2 RMB undervaluation 26 February However, things are not that simple. Fundamentally, China s basic balance surplus at 4.5% of GDP is still too large to be consistent with RMB equilibrium. Further, both the current account and basic balances have started to rise again since 2012 (Chart 1). I have long argued that the narrowing of China s current account surplus would be an elusive indicator for the correction of RMB undervaluation 1. The reason rests with commodity prices. China has turned from a net exporter of primary products and raw materials into a chronic net importer since the 1990s as a result of industrialisation. Its raw materials trade deficit has grown from less than 1% of GDP in the early 1990s to over 6% (Chart 2). The point is that China s shrinking current account surplus has more to do with the rise in commodity prices which has created a negative terms-of-trade shock on its external accounts than with a genuine change in the trade structure that rebalances Chinese demand towards more imports. Global commodity prices, as measured by the CBR index, started rising in 2002 and cutting into China s current account surplus which peaked at 10.1% of GDP in 2007 (Chart 3). Commodity prices then started falling in 2011, and in the following two years China s current account surplus turned up again. If this relationship holds, further weakness of commodity prices would push up China s current account surplus through a positive terms-of-trade impact. Evidence also shows that there has not been any change in China s trade structure that could have caused the decline in its current account surplus. China s trade surplus with its two largest trading partners, Europe and the US, has continued to rise despite a fall in its overall trade surplus since 2008 (Chart 4). In other words, despite the RMB s steady appreciation, it has not caused a fundamental shift in China s trade balance to favour imports over exports. So the sharp decline in the current account surplus (which is dominated by the trade surplus) since 2007 is not really indicative of the RMB approaching equilibrium. 1 See The Renminbi s Slow Move Toward Equilibrium Don t hold your breath waiting for quick interest rate liberalization and capital account convertibility, The International Economy, Magazine of International Economic Policy, Summer 2012.

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4 RMB undervaluation 26 February RMB volatility and internationalisation The RMB will only depreciate on a sustained basis when China s balance of payments turns into a deficit, but there are no signs of this happening in the short-term. Even if China s exports and imports and net FDI flows were to grow at the same rates as in 2013, commodity price weakness could easily push up its current account surplus to over 3.0% through a positive terms-of-trade shock. But China s exports may grow faster than in 2013 due to stabilising global demand and its imports may grow more slowly under domestic structural reform pressures. So the chances are high that China s current account surplus may expand again, putting upward pressure on the RMB. International pressure for a revaluation of the RMB will mount. However, there need not be a sharp rise in the RMB exchange rate because, from a policy perspective, Beijing will only relax its control gradually. From a market perspective, since China s capital account is gradually opening up, there will be times when capital outflows will overwhelm capital inflows from the current account, resulting in temporary RMB depreciation. We have seen this happen since Hence, RMB volatility will likely rise alongside a widening current account surplus this year. Beijing should take this as an opportunity to expand the RMB trading band 2 to accommodate some of the economic volatility and to fend off international pressures on revaluing the RMB. Rising RMB volatility also increases the foreign exchange risk. This should help RMB internationalisation by prompting more foreign exporters and importers to use RMB for trade settlement. According to SWIFT, the RMB overtook the EUR in October 2013 to become the second-most used currency in trade finance, with a market share of 8.7% compared to 1.9% in January Such rapid growth was mainly due to the expansion of cross-border payments in RMB by (mostly Chinese) companies seeking to reduce FX risk. Chi Lo Senior Economist, BNPP IP 2 In 2007, Beijing expanded the RMB-USD trading band from 0.3% to 0.5% +/- the mid-point rate set by the PBoC at the beginning of each trading day, and the RMB-non-USD currencies trading band from 1.5% to 3.0%. Then in 2012, it expanded the RMB-USD trading band further to 1% +/- the PBoC s daily official trading rate.

5 RMB undervaluation 26 February DISCLAIMER This material has been prepared by BNP Paribas Asset Management S.A.S. ( BNPP AM )*, a member of BNP Paribas Investment Partners (BNPP IP)** and is made available in Australia by BNP Paribas Investment Partners (Australia) Limited ABN , AFSL , ( BNPP IP ). It is produced for general information only and does not constitute financial product advice. You should consider obtaining independent advice before making any investment decision in relation to any financial product referred to. The value of investments can go up and down. Past performance is not necessarily indicative of future performance. Any opinions included in this document constitute the judgment of the document s author at the time specified and are subject to change without notice. Given economic, market and other risks, there is no guarantee that any investment strategy referred to in this document will achieve its objectives. The contents of this document are based upon sources of information believed to be reliable, but no warranty or declaration, either explicit or implicit, is given as to their accuracy or completeness. BNPP IP to the extent permitted by law, disclaims all responsibility and liability for any omission, error, or inaccuracy in the information or any action taken in reliance on the information and also for any inaccuracy in the information contained in the document which has been provided by or sourced from third parties. *BNPP AM is an investment manager registered with the Autorité des marchés financiers in France under number 96-02, a simplified joint stock company with a capital of 64,931,168 euros with its registered office at 1, boulevard Haussmann Paris, France, RCS Paris ** BNP Paribas Investment Partners is the global brand name of the BNP Paribas group s asset management services.