I don't understand the Renminbi. I don't understand how and when China plans to 'internationalize' the Rmb. I don't understand how much capital really moves in and out of the economy. I don't understand why the yuan has been hitting multiple highs against the dollar since July...but of course, I could always try and shed some light. Let me start with some facts, some old, some new:
1) At the turn of the century, the US accounted for a quarter of China's exports, now it accounts for just a sixth. LatAm+SE Asia account for the same proportion.
2) In the past five years, the Rmb has appreciated by a fifth against the dollar but only a tenth on a trade-weighted basis.
3) On two consecutive days last week, the Rmb almost hit the upper limit of its daily trading band against the dollar.
4) Over the past 12 months, China's trade surplus is up nearly USD 200 billion and net foreign direct investment has been about USD 30 billion.
Here's what has happened to the Real and Nominal trade weighted exchange rates over the same time period as well as the bilateral rate, which hit a 19 year high of 6.2530! (the NEER-REER is Left Scale, USDCNY is right)
Which obviously begs the question, what is the PBOC doing?
Ok, let me rewind. Essentially, an economy with a controlled exchange rate and the ability to set its own monetary policy should have a direct trade-off between its legal capital flows and its official reserves. If there's an imbalance between recorded and reported flows and the change in reserves, one immediately should smell hot money. In China's case, the status quo, loosely speaking - is ever increasing reserves above expectations, which suggests inward/onshore speculative flows.
As it turns out, quite the opposite as happened. Look at 4) above - according to general estimates and basic calculations (factoring the returns on existing reserves plus currency changes) - you get another USD 50-100 billion which is a huge margin by all means. If you add all that up, there's a bandwidth of USD 280 - 330 billion, as Simon Rabinovitch estimates over at beyondbrics.
But this is what happened to forex reserves (USD billion).
Does that look like a few hundred billion? Nope, 88.32 to be precise and that's a USD 200-250 billion short fall there. Is it really possible that all that has been moved ashore? As it turns out, there's a more than partial explanation - the majority of which has to do with the central bank and the rest of the banks.
Essentially, if Chinese company X were to receive a payment in dollars for its goods, it could/would officially convert them into Rmb (at a fixed beneficial rate) and the dollars would end up in the central bank as official reserves. The company would use the Rmb to produce/manufacture/pay wages etc. This leads to the simple explanation that if company X stops doing this as much then the dollars end up in commercial banks rather than in the official reserves. So what's happened to foreign currency deposits at Chinese banks? They's increased by 60% yoy, a good USD 158 billion that gets offset with our initial 200-240 bandwidth.
What about the remaining USD 40-80 billion?
An increase in Rmb payments to settle invoices and trades. This is where the 'internationalization' issue sets in. At least, for such kinds of settlements, there's not much doubt that China has been pushing for a more active Rmb role. Hong Kong, though an SAR, operates under a free capital, currency board framework thus being positioned as a prime offshore market. If the Rmb doesn't appreciate in line with expectations, a foreign company Y would send Rmb back to pay for a Chinese export. This is measurable stuff through the HKMA - Rmb deposits in Hong Kong have fallen by approx USD 9 billion (currency converted).
That's still another USD 30-70 billion which is a far cry from the initial starting point, but it still merits enough thought and almost inevitable conclusions. China suffers from significant capital movement (significant could be a misnomer, because it's less than a percentage point of GDP) but that's Chinese output!
Unleashed on smaller markets such as Hong Kong, Sydney, Singapore, Cyprus it could have significant impacts on asset prices.
If there's a change in perception of Rmb appreciation, investors naturally start opting for dollars - but there comes a point when the PBOC has to say enough before a more dangerous trend is set.
I think, but don't remember for sure, that I read an excerpt of a note somewhere from a Credit Agricole analyst that dwelled on the impact of US politics on China's Rmb policy but it's impossible for anyone to measure something like that.
Over at Alphaville, David Keohane uses similar estimates concluding naturally that an estimate the size of the initial outflow runs opposite to the recent new found strength of the Rmb. It wasn't too long ago (May-July), that the Rmb depreciated sharply on the back of outflows and China's first BOP deficit in 14 years.
Josh Noble, at beyondbrics, points to the seemingly depressing macro-fundamentals that might be a bit too dooms-dayish, a reversal of outflows, Obama over Romney and QE3 leading to higher import costs.
Meanwhile, BNY Mellon's Neil Mellor wrote about the long-term fortune of the euro and its role as a reserve currency, the logic being that USD accumulation (via sterilized intervention to check local currency appreciation) have led to a diversification into the euro as well as other currencies. Using China's reserves as a proxy, it means there is little doubt that fundamental support for the euro has weakened over the past year (less USD accumulation implies less reserves for euro-swaps).
The WSJ has an interesting report on the draining of the Chinese money-basin, so to speak. It uses similar outflow estimates among stories of citizens finding ways to circumvent the capital restrictions. Moreover, it has a couple significant statements - one by Michael Pettis stating that if local businessmen take money offshore in such a fragile global environment, it can't be a good sign. The other is by the well-known Eswar Prasad who reiterates what everyone assumes and realizes, "The wealthy in China have always had an open capital account".
The general consensus is obviously to wait a little longer for more data. But this is a really really interesting spell for the Rmb and China's policy makers. There's a lot going on.
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