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Tuesday, May 25, 2021
Post-Pandemic RMB Stability is Crucial
ANBOUND

Driven by rising commodity prices and the weaker U.S. dollar, market expectations for a significant appreciation of the renminbi (RMB) have been rising. On May 25, the central parity rate of the RMB against the U.S. dollar rose 125 basis points to 6.4283. The onshore RMB rose to 6.4060 as of 1830 Beijing time, its highest level in nearly three years; the offshore RMB rose to 6.4007, and once broke the 6.4 mark to 6.3943 during the day. The appreciation of the RMB has brought about obvious changes in China. In particular, it accelerated the entry of overseas funds into China's capital market. On that day, a net inflow of nearly RMB 20 billion into the A-share market through the Shenzhen/Shanghai-Hong Kong Stock Connect led to a rare rise in the A-share indexes.

In fact, this round of RMB appreciation has been going on since early April. Since the beginning of April, the onshore RMB has appreciated 2.45% against the U.S. dollar. At present, a number of hedge funds have bought one- and two-month RMB call options with a strike price of around 6.2. This reflects that there is still plenty of room for the RMB to appreciate.

The reason for this round of RMB appreciation is that, on the one hand, the continuous improvement of China's economic fundamentals and the expansion of foreign trade. On the other hand, there is an obvious correlation between the appreciation of RMB and the decline of the U.S. dollar index. With taper tantrum and inflation expectations in the U.S., the U.S. dollar index has gone through a cycle of gains and losses this year, peaking above 93 from around 90. Since then, with Federal Reserve's policy unchanged and U.S. job growth sluggish, the U.S. dollar index has started to pull back in April, falling back to its current high of around 90, down about 3% from its April high. This has also led to fluctuations in the RMB exchange rate.

As it stands, the negative effects of the changes in the U.S. dollar index caused by the U.S. ultra-loose monetary policy are spreading around the world as energy and commodity prices rise. This has increased the imported inflation pressure on China. In that case, a stronger RMB would help ease the pressure. The appreciation of the RMB will attract more capital inflows, which will be beneficial to the capital market in the short term. However, the appreciation of the RMB also has a negative impact on China's foreign exports and brings greater pressure to exporters. At the same time, RMB appreciation may still be subject to the risk of downward adjustment once the USD index changes, as it did in the previous round, so it does not constitute a long-term stable trend.

Judging from the economic and capital market changes since the COVID-19 pandemic, the fluctuation of the RMB exchange rate is actually more influenced by the monetary policy of the Fed. ANBOUND has pointed out that while the U.S. dollar is still dominant in the international market, the Fed's policy changes will not only bring about volatility to the U.S. economy and capital markets, but also impact the stability of currencies around the world, including the RMB. If the Fed changes its monetary policy and scales back quantitative easing because of the inflation in the United States, it will undoubtedly affect the stability of the RMB exchange rate. Therefore, in the post-pandemic period, when the economic recovery between China and the United States is out of sync, the fluctuation of the RMB exchange rate will bring great disturbance to China's overall economy and capital market. Short-term overseas capital flows will increase the volatility of the capital market, and the U.S. dollar liquidity flood will also bring inflationary pressure to China. Once the excessive fluctuation of the RMB exchange rate causes panic, it will affect the stability of China's economy and capital market.

In terms of policy, the Financial Stability and Development Committee (FSDC) and the People's Bank of China (PBoC) have issued several statements on the RMB exchange rate issue, emphasizing the stability of the RMB exchange rate. On May 21, the FSDC held a meeting and pointed out that the RMB exchange rate should be kept stable at a reasonable and equilibrium level. On May 23, Liu Guoqiang, deputy governor of the PBoC, stated that the current foreign exchange market in China is self-balanced, the RMB exchange rate is determined by the market, and the exchange rate is expected to be stable. The future trend of the RMB exchange rate will continue to depend on market supply and demand and changes in the international financial market, with two-way fluctuations becoming the norm. At the same time, Liu stressed that the RMB exchange rate mechanism will remain stable. The policy stance is, in effect, to cool expectations of RMB appreciation and "reverse" the market's view of a moderate appreciation of the exchange rate to combat imported inflation pressures. In terms of regulation, although regulators have shown greater tolerance for RMB exchange rate fluctuations at present, the stability of the RMB exchange rate is still their policy goal. Any unilateral expectation would do a lot of harm, which is why regulators have repeatedly emphasized the two-way fluctuations of the RMB.

ANBOUND has pointed out that in the post-pandemic period, the trend of uneven global economic recovery has become more and more obvious, which will occur not only between developed countries, but also between developed countries, emerging markets, and underdeveloped countries. At the same time, in the case of the U.S. dollar liquidity flood, the volatility of the international capital market will increase. In this case, China needs to position itself as a haven for stable economic development to avoid negative impacts on China. The stability of the exchange rate is actually a stabilizer for the entire Chinese economy.

Therefore, given the uneven recovery of the U.S. and Chinese economies in the post-pandemic period, China should consider a certain degree of "decoupling" between the RMB and the U.S. dollar, so that its economy can get rid of the impact of the monetary policy of the Fed to some extent. In addition, while adhering to its own monetary policy, China needs to consider stepping up the formation of a global pricing mechanism for the RMB exchange rate under the new development pattern, so as to achieve the relative stability of the RMB exchange rate.

Final analysis conclusion:

Short-term changes in the RMB exchange rate are not only related to the stability of China's economic fundamentals, but also influenced by the fluctuations of the U.S. dollar. Excessive short-term fluctuations of the RMB exchange rate are actually detrimental to China's economic recovery and development. China should consider a certain degree of "decoupling" between the RMB and the U.S. dollar in order to maintain stable domestic economic development.

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