View the article online at http://citywire.co.uk/money/article/a583713
China's clever path towards currency liberalisation
The move to allow the renmimbi to trade by up to 1% a day against the dollar is the latest in series of baby steps in liberalising the currency, explains Chris Towner of HiFX.
The Chinese authorities are letting their currency go and play in the park, says Chris Towner of HiFX, but they're holding its hand to make sure it doesn't wander off into the nettles.
Pressure to liberalise
As the Chinese economy has grown, there has been growing pressure on the country to liberalise its currency so that it flows freely within the international foreign exchange markets, which amount to a daily volume of approximately 4 trillion US dollars.
Over the past few years the Chinese have tweaked their approach of managing their exchange rate to the US dollar from a peg to a 'managed float', which has gradually allowed the renminbi to strengthen against the US dollar.
Since relinquishing the peg in 2005, when the renminbi was at 8.28 to the US dollar, we have seen the currency strengthen by approximately 24%, and it currently trades just above the 6.30 level.
The latest step been to allow the renmimbi to trade by up to 1% against the US dollar per day, which allows potential movements, for example, of between 6.237 and 6.363, if the renminbi were to be trading at 6.30.
This has increased the potential for volatility, but the timing of this move is clever as it comes at a time of low levels of implied volatility in the FX markets. For example, recently pound-to-dollar and pound-to-euro rates have also been trading within contained daily ranges of roughly 1%.
Therefore, what the Chinese have done here is to introduce a degree of normalisation in trading of their own currency while still having ultimate control as to where it trades and not fully exposing it to the speculators within a low-volatility environment.
Given the robust growth levels of China – 8.1% at the latest reading – it is often presumed in the foreign exchange markets that if the Chinese renminbi were allowed to float freely then we would see a strengthening in this currency.
However, we also note clever timing here as the Chinese authorities have recently downgraded their forecast growth levels to 7.5% from 8%, thus allowing some doubt as to whether this currency would strengthen. In reaction to the news, we have actually seen the renmimbi weaken.
Best of both worlds?
Therefore, at their own chosen pace, we are seeing the Chinese move closer to fully liberalising their currency, without completely exposing it to the international foreign exchange markets.
This is similar to taking your child to the park but never letting go of his or her hand. One day, though, the hand will be let go, but by this time, price implications and behaviour will pretty much be priced in.
The reason for this ‘safe and gradual’ approach is to buffer the potential damage to the Chinese economy from a sharply appreciating currency. China is still very reliant on exports, and an appreciating currency can reduce the volume of exports, as higher prices for foreigners of goods exported from China will reduce demand.
To surmise, China continues to take baby steps, navigating a course that tries to keep international frustrations at bay while at the same time affording some protection to the economy.
The Citywire guide to investment trusts
In association with Aberdeen Asset Management
More about this:
Tools from Citywire Money
From the Forums
Weekly email from The Lolly
Get simple, easy ways to make more from your money. Just enter your email address below
An error occured while subscribing your email. Please try again later.
Thank you for registering for your weekly newsletter from The Lolly.
Keep an eye out for us in your inbox, and please add email@example.com to your safe senders list so we don't get junked.