- 2018-11-27
Seven major changes in the fundamentals of the RMB exchange rate
The current round of RMB devaluation began in mid-April, and the exchange rate against the US dollar broke 6.93 in mid-August. It took a total of 4 months. With the recent US dollar peaking and falling and the central bank’s stabilizing expectations, this round of devaluation has come to an end. We found that compared with the 16-month long devaluation after the “811” exchange rate reform in 2015, the fundamentals of this round of devaluation have undergone seven major changes. Combing these changes will help us better judge the future trend of the RMB exchange rate.
Change 1: The domestic economic situation is different
With the opening of my country's supply-side structural reforms in 2016, my country's economy has experienced a round of short-term recovery. From a quarterly perspective, in the fourth quarter of 2016, my country’s current GDP growth rate rose from 6.7% in the previous quarter to 6.8%, and in the first quarter of 2017 it rose to 6.9%, and maintained this growth rate for three consecutive quarters. From the perspective of motivation, the continued recovery of external demand, consumption upgrades and infrastructure, and real estate investment underpinning are the main supports. The sound economic fundamentals also laid the foundation for the RMB exchange rate to return to the appreciation range in 2017.
This time, the RMB exchange rate once again touched the 6.9 range, and the uncertainty faced by the domestic economic situation has greatly increased: in the face of a complex trade environment, the growth of external demand is weak, and the contribution of net exports to GDP has once again turned negative; infrastructure has dragged down investment growth. Decline, the year-on-year growth rate of fixed asset investment in the first 7 months fell to a historical low of 5.5%; actual consumption growth rate dropped to 6.5%, which was lower than GDP growth rate for the first time, and the voice of “consumption downgrade” continued to be heard. On the whole, compared with the last time the RMB exchange rate hit 6.9, the current economic difficulties have increased.
Change 2: The international environment and the background of the dollar's strength are different
During the two rounds of RMB devaluation, my country faced a more complicated international environment and a strong US dollar background, but the reasons behind them were different. From the second half of 2014 to the first half of 2017, the U.S. dollar index remained at a strong high above 95. After Trump was elected at the end of 2016, it even broke 100. At that time, the market focus was on Trump’s Reagan-style strong U.S. dollar reverie and the strong U.S. Economic recovery prospects, but soon the "Trump deal" was falsified. The international environment for the current round of RMB devaluation is even more complicated. The economic recovery of the United States and Europe, Japan, and other economies has clearly diverged. The United States is expected to raise interest rates four times in 2018, while the normalization of monetary policies in Europe and Japan is slow, and emerging market currency markets have suffered. Serious impact, the shadow of the trade war looms over the world. Compared with the last time the RMB exchange rate broke through 6.9, the US dollar index is at a lower level this round, and there is still room for continued upward movement.
Of course, in the medium and long term, the U.S. economy will not be able to survive alone. The weakening impact of tax cuts, the Fed’s continued interest rate hikes to raise borrowing costs, increasing aging, and the risks brought by the deterioration of the international trade situation will restrict the future economic growth prospects of the United States. At the same time, uncertainties such as the increase in the federal government’s debt burden and Trump’s intervention have also constrained the U.S. dollar. It is still difficult for the U.S. dollar to break through 100 as it did last time.
Change 3: my country’s international balance of payments is different
From 2016 to 2017, my country's balance of payments as a whole showed the characteristics of "current account surplus, financial account deficit, significant outflow of short-term capital (hot money), and rapid consumption of foreign exchange reserves". Specifically, the first is the current account surplus in 2016 of about 200 billion U.S. dollars, of which the goods surplus is about 490 billion, and the service deficit is about 230 billion; the second is the deficit of 410 billion non-reserve financial items, and the net error and omission deficit is 230 billion; 3. In order to balance international payments, foreign exchange reserves have consumed about 440 billion U.S. dollars. In detail, in the devaluation of the renminbi in 2016, the concentrated exchange of foreign exchange by residents, large repayments of US dollar loans by enterprises, and cross-border arbitrage were the main reasons for the large deficit in financial items and errors and omissions.
In contrast, my country's international balance of payments in the first half of 2018 was completely different, with the overall characteristics of "current account deficit, financial account surplus, insignificant outflow of short-term capital (hot money), and a small increase in foreign exchange reserves." Specifically, first, there was a small current account deficit of US$28.3 billion in the first half of 2018, which was mainly affected by the reduction of my country’s goods surplus and the expansion of the service deficit under the Sino-US trade war; the second was a surplus of US$120 billion in non-reserve financial items. The deficit of errors and omissions has also been relatively reduced; third, foreign exchange reserves have increased by approximately US$50 billion. The reasons for this are not only the expansion of my country's capital market opening up and the decline in valuations that have increased the attractiveness of foreign investors, but also the strict control of foreign investment and the weakening of residents' panic buying of foreign exchange.
Change 4: The importance of exchange rates in macro policy objectives is different
In the last round of devaluation, maintaining the stability of the RMB exchange rate is of higher importance in the current macroeconomic policy. On the one hand, the rapid depreciation of the RMB after the "811" exchange rate reform exceeded expectations. The sudden reversal of the expected long-term appreciation of the RMB triggered a strong "herd effect". At that time, the domestic economic growth pressure was not prominent, and the main task was supply-side reform. Three major battles proposed. Therefore, "preserving the exchange rate" once became an important macro policy goal.
In this round of devaluation, the new framework for the RMB exchange rate reform has basically taken shape, and the market is more accepting of exchange rate fluctuations. At the same time, affected by the increasing downward pressure on the economy, the importance of internal equilibrium relative to external equilibrium has become more and more prominent. Increased flexibility of the exchange rate leaves more room for the independence of monetary policy. Therefore, in the main macro policy objectives, the "anchor" of the exchange rate has been relatively loose.
Change 5: Different marginal inclination of monetary policy
Although the two rounds of monetary policy depreciation have both sounded stable, there is still a difference of tightness in terms of marginal changes. During the last round of devaluation, the margin of monetary policy was tight. At the same time, credit expansion slowed down under strict financial supervision. The growth rate of M2 dropped from 14% to single digits. Market interest rates rose. China-US interest rates remained stable and even widened.
The currency environment for the current round of RMB devaluation has gradually turned to easing, and the Sino-US interest rate gap has further narrowed. Since the beginning of this year, the central bank has increased the liquidity supply in the money market through targeted RRR cuts, MLF more-than-expected additions, forums and window guidance, and increased open market launches. Expectations for monetary easing have increased, and interest rate bond yields have fallen. The trend is significant. Especially since mid-to-late July, money market liquidity has been exceptionally abundant, and the accumulation of funds in the inter-bank market has led to a straight decline in money market interest rates. The U.S. Treasury bond interest rate has continued to rise since the Federal Reserve began to raise interest rates steadily at the end of 2015. This has led to the recent inversion of the short-term interest rate differential between China and the United States for the first time since the outbreak of the 2008 subprime mortgage crisis.
Change 6: Regulatory response methods and strategies are different
During the current round of RMB exchange rate devaluation, the central bank basically did not carry out normal intervention. The policy-makers’ tolerance for exchange rate fluctuations has increased significantly compared with 2016, and the market’s decision on exchange rates has increased. The recent exchange rate stabilization policies include the verbal guidance of the supervisory authorities, raising the foreign exchange risk reserve ratio for forward foreign exchange sales, restricting banks in the free trade zone from depositing or debiting RMB funds overseas through interbank current accounts, and restarting the middle price. Counter-cyclical factors, etc. On the whole, the goal of the policy is mainly to prevent and control procyclical behavior and herding effect by guiding expectations. Under the guidance and control of the above-mentioned policies, my country's cross-border capital flow and foreign exchange market have generally remained stable, and the scale of foreign exchange reserves has increased slightly, generally stabilizing at a level of about 3.1 trillion US dollars.
Change 7: The rate of exchange rate depreciation is different from the short-term capital outflow
Affected by many different aspects of domestic and foreign economic fundamentals, international balance of payments, policy-level response ideas and methods, and as a result, the speed of the two rounds of RMB devaluation is also completely different. The last round of depreciation was a "slow depreciation" that lasted 16 months, while this round was a "quick depreciation" that lasted only 4 months. The comparison found that the impact of the last round of “slow depreciation” and the current round of “quick depreciation” on capital flows is different. The dispute over "foreign reserves" instead provides time and space for capital outflow. According to the author’s calculations, during the 16-month period of “slow depreciation”, the net outflow of broad short-term capital (securities investment + currency and deposits + derivatives + net errors and omissions) was US$670 billion, with an average monthly outflow of more than 40 billion. Under the “quick depreciation” situation, the cumulative outflow was less than 80 billion U.S. dollars, and the average monthly outflow was less than 20 billion. From the perspective of bank foreign exchange settlement and sales, the previous round of depreciating banks' foreign exchange settlement and sales deficit totaled more than 610 billion U.S. dollars, with an average monthly outflow of approximately 38 billion. In this round of 4 months, the cumulative foreign exchange settlement and sales surplus was 22.6 billion U.S. dollars, and the average monthly surplus was 5.6 billion. Cross-border capital flows were basically balanced.
Basic judgment on the future trend of RMB exchange rate
The current economic situation, the international trade environment, and the marginal tendency of monetary policy are not conducive to the strengthening of the RMB exchange rate, but from the perspective of international capital flows, the choice of supervisory tools and the upward space of the US dollar, it is conducive to maintaining the stability of the RMB exchange rate. Generally speaking, before the arrival of new fundamental changes, the RMB exchange rate will return to two-way fluctuations in the near future. Specifically:
First, it is expected that the RMB exchange rate will have a strong support near 7. Judging from the increase in the use of various policy tools for exchange rate stabilization by the supervisory authorities in early August, the short-term central bank's tolerance point for exchange rates does not exceed 7. At the same time, compared with the previous round of devaluation, the supervisory authorities have more abundant response methods and experience, and short-term capital flows are also somewhat afraid.
Second, the current equilibrium range of the RMB exchange rate should be between 6.7 and 7.0. This means that the current round of depreciation is expected to come to an end, but the possibility of a sharp appreciation of the RMB exchange rate the last time it turned around is unlikely. This is due to the current downward pressure on my country’s economic growth, a more complex trading environment, changes in the interest rate differential between China and the United States, and exchange rate policies. Decline in importance and other fundamentals.
Third, the flexibility of the RMB exchange rate will further increase in the future. This is not only the general direction of exchange rate reform, but also the need to increase the independence of monetary policy. At the same time, my country's adherence to the reform direction of opening wider to the outside world also requires exchange rate flexibility.
Fourth, the impact of short-term capital flows on exchange rate shocks has declined, and the impact of fundamentals has increased. From the perspective of the balance of payments and capital outflows, after the previous round of devaluation, market entities have become more mature, speculative demand has relatively converged, and the internal and external pressure difference (the degree of exchange rate distortion) has decreased. This will reduce the impact of speculative short-term capital flows. In the future, the fundamental impact of the exchange rate will increase further.