Foreign exchange: Renminbi internationalization to continue in 2012

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By:
Peter Garnham
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Depreciation eases concern over speculation; Internationalization might pressure euro

China faces a new currency challenge as the prospect of a slowdown in its economy heightens, which is likely to result in a renewed push towards the internationalization of the renminbi.

Talk of the renminbi usurping the dollar as the world’s reserve currency has been replaced by concerns that China is struggling to contain capital flight.

The latest figures from the People’s Bank of China provide confirmation that foreign investors were pulling money out of China in the final quarter of 2011.

Data from the Chinese central bank show that there was a Rmb27.9 billion ($4.4 billion) reduction in the renminbi positions of financial institutions accumulated from foreign exchange purchases in November, after a fall of Rmb24.9 billion in September.

With foreign investors repatriating capital at the fastest pace for 11 years, the renminbi has been under sustained pressure. This has ensured continued dollar sales from China’s vast foreign exchange stockpiles to keep the currency stable.

"With the trade deficit narrowing, foreign capital being withdrawn, and the dollar enjoying healthy demand, the PBOC is facing an incredibly difficult task to thwart the pressure for currency depreciation," says Michael Derks, chief FX strategist at FxPro.

He says that Chinese policymakers, left to their own devices, might actually now be prepared to let the currency depreciate slightly given the strength of the dollar, the narrowing trade gap and the reduced international demand for the renminbi.

But of course Beijing is well aware that the value of the renminbi remains a controversial topic, especially now that the 2012 US presidential campaign is under way.

Although the US has so far avoided branding China as a currency manipulator, that stance could change if Beijing were to be seen to be allowing its currency to fall to protect its domestic economy.

Analysts have, however, been cutting their forecasts for the pace of renminbi appreciation in the wake of the slowdown in Chinese growth and the move by the PBOC to cut banks’ reserve requirements.

Slower appreciation

Paul Mackel, head of Asian currency research at HSBC, says China’s monetary policy easing and expectations of more to come support the view that the pace of renminbi appreciation will slow in 2012 as inflationary pressures ease. "We reiterate our forecast for only 3% appreciation of the renminbi in 2012," he says.

Mackel expects the continued internationalization of the renminbi, rather than appreciation, to be the policy theme in the currency for the coming year, however.

Many believe that slower renminbi appreciation should not detract from growth in the development of the offshore market in the currency.

Indeed, some say the presumption that the renminbi has been a one-way upward bet might have hindered the development of the offshore market in the currency.

The growth of offshore renminbi lending, for example, might have been constrained by the limited incentives to borrow in an appreciating currency. Thus an end to persistent renminbi appreciation expectations would be unlikely to slow the overall process of internationalization as it will shift development to other areas.

China may tap bumper reserves
Foreign exchange reserves (minus gold) 
 Source: China’s State Administration of Foreign Exchange

What is more, if policymakers’ concerns about currency speculation fade, it could encourage them to speed up the liberalization of the whole financial system.

HSBC believes there are likely to be substantial moves towards expanding offshore renminbi settlement beyond Hong Kong.

The bank says that Singapore would be a sensible first stop, as it boasts deep, developed financial markets, has a close commercial and policymaker relationship with China, and is also a financial and trading hub for the rest of the Asian region.

There have also been reports that London will become an offshore renminbi trading centre. "A near-term expansion into London, the pre-eminent global hub for FX and metals, would signal an even quicker pace of renminbi internationalization," says Mackel. "The creation of additional offshore renminbi centres would expand the existing regime rather than create competing systems."

In the wider FX market, analysts argue that the increased liberalization and internationalization of the renminbi is likely to put pressure on the euro.

China’s foreign exchange reserves 

 China’s foreign exchange reserves

Simon Derrick, head of global currency research at Bank of New York Mellon, says that liberalization of the renminbi is likely to lead to decreasing Chinese foreign exchange reserves, which have ballooned from $227 billion to $3.2 trillion in the past decade. It is the diversification of these reserves away from dollars, he says, that has been a key support for the euro in recent years.

Indeed, Derrick says the only times that the euro has come under sustained pressure over the past 10 years has been when Chinese FX reserve growth has been stagnating.

It might be counterintuitive, but Chinese efforts to internationalize the renminbi and reduce the country’s reliance on the dollar could have a much bigger effect on the euro than the US currency.