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Friday, September 18, 2020
"Internal Circulation" and the Prospect of RMB Exchange Rate
ANBOUND

On the morning of September 15, both the onshore and offshore RMB exchange rates rose above 6.8 against the U.S. dollar, hitting a new high for this round of appreciation and returning to the level at the beginning of May 2019. If measured from its lows in late May, the offshore RMB exchange rate rose more than 4,000 basis points against the dollar as of the new high set on the morning of September 15.

The RMB's rise to a 16-month high sparked a bullish trend in the market. Market participants said that the onshore RMB day trading volume was significantly higher than recent levels. Some traders said that on September 15, the intraday trading and banks' trading were mainly shorting the USD/RMB exchange rate, and the domestic trading activity also increased significantly. Foreign institutions have been bullish on the RMB. Nomura's report said the offshore RMB could rise above 6.65 per dollar by the end of the year. Citigroup expects the RMB to continue to perform well given China's leading economic recovery, improved balance of payments, and strong capital market inflows.

The recent continued appreciation of the RMB has also sparked debate about its future direction. The recent controversy between Gao Shanwen of Essence Securities, and Liu Yuhui of Tianfeng Securities, is quite notable. Gao Shanwen's main argument is that the RMB's depreciation process over the past five years should be over. The RMB exchange rate has now not only reached the bottom, but is likely to be undervalued. Thanks to the fundamental factors, the RMB has moved into, or will soon move into a prolonged appreciation process. According to Liu Yuhui, it is difficult to determine the current appreciation trend of the RMB when ignoring the basic background of two major tight constraints. The first of the so-called two major tight constraints is that there has been a nominal exchange rate and real exchange rate gap in the RMB exchange rate three years ago or even earlier, and the gap diverges rather than converges. Second, there are strict capital controls in China. Those who disagreed with the view that the RMB exchange rate would appreciate in the long run actually implied the view that those who expected a long-term appreciation of the RMB seemed to have overlooked the issue of the RMB's monetary value.

To judge the long-term trend of the RMB exchange rate, one must first explain why there is a sustained round of appreciation of the RMB. To put it simply, there are two factors for the RMB exchange rate: Externally, it is the continued weakening of the U.S. dollar index that makes the U.S. dollar depreciated against a series of currencies, including the RMB. In fact, if we look back at the current round of RMB movements, it began roughly at the end of May. As the dollar index continued to weaken, it became a direct contributor to the appreciation of the RMB against the dollar. Internally, there are many factors driving up the RMB exchange rate. For examples, China was the first to succeed in the COVID-19 pandemic prevention and control, its economy was the first to start recovery, and China is expected to be the first to resume positive growth among major economies. Over the past two years, there has been a stricter management of capital outflows, leaving much of it confined to the domestic market. In addition, as the Fed's "massive easing" led to lower U.S. Treasury yields, while China did not implement "massive easing" after the outbreak of the pandemic, these practices have widened the U.S.-China interest rate differential and attracted more foreign capital inflows into RMB assets.

It should be pointed out that, under both internal and external influences, the recent appreciation of the RMB is to some extent a passive appreciation, because the decline in the dollar index (about 10%) is greater than the appreciation of the RMB against the dollar (nearly 5%), meaning that it is mainly the depreciation of the dollar that has led to a disguised appreciation of the RMB exchange rate, while the RMB is likely to be depreciated against other currencies. In addition, China's control of foreign exchange outflows has also resulted in some "distortions" in the currency's exchange rate performance. In terms of the current and future situation, China is likely to maintain relatively strict control over capital outflow for a long period of time. Especially after emphasizing the "internal circulation", the control over foreign exchange outflow will become stricter, which is likely to become a norm.

For researchers of the Chinese economy, the emphasis on the "internal circulation" has eroded the significance of relevant historical economic figures. For example, the number of Chinese outbound tourists in the past few years is measured in hundreds of millions, and the number of Chinese outbound tourists from 2014 to 2019 was 107 million, 117 million, 122 million, 131 million, 150 million, and 155 million respectively. In 2012, Chinese tourists spent more than USD 100 billion overseas; in 2015, it exceeded USD 200 billion; and in 2017, it amounted to USD 258 billion. This year, due to the impact of the pandemic, the above-mentioned overseas travel spending has been almost wiped out, which has objectively reduced a large amount of foreign exchange outflow. While this change has been influenced by the pandemic, it has also been reinforced by the implementation of the "internal circulation".

Final analysis conclusion:

The RMB exchange rate depends on the changes of several internal and external factors, especially in the context of the emphasis on "internal circulation", where the influencing factors on the RMB exchange rate will change, and the economic significance of several data will also be different from the past. Against this backdrop, it is hard to judge that the RMB is destined for long-term appreciation.

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