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Market Avenue

UPDATED: March 3, 2014 NO. 10 MARCH 6, 2014
Sustained Yuan Appreciation Unlikely

Recently, the continued depreciation of the yuan has aroused extensive attention. Some think it was the result of intervention by the People's Bank of China, the country's central bank, to pour cold water on expectations of renminbi appreciation. If it's true, the central bank has set out to make preparations for prospective exchange rate reform.

According to the report on the implementation of monetary policies in the fourth quarter of 2013, the central bank would further improve the renminbi exchange rate formation mechanism by highlighting the role of the market in affecting exchange rates and enhancing the flexibility of the two-way movement of the exchange rate.

From the launch of the exchange rate reform to the end of 2013, the renminbi exchange rate against the U.S. dollar rose 35.7 percent, while China's consumer price index (CPI) grew at an annual average rate of 3.1 percent. In 2013, the renminbi exchange rate increased by 3 percent, three times as fast as that in 2012. The upward trend didn't come to an end until February 2014.

Theoretically speaking, when the renminbi appreciates, its purchasing power will be strengthened, and the cost of imports will be lowered, which would greatly benefit domestic consumers. However, this is far from the truth. In reality, the renminbi keeps depreciating in the domestic market.

Why does this happen? The divergence mirrors the distortion of renminbi exchange rates and probable human intervention. There are also significant errors in the statistics of renminbi purchasing power and consumer prices.

The above-mentioned two factors have combined to push the renminbi to appreciate externally and depreciate internally. This will encourage capital outflows or more specifically, wealth exports. As a result, China is forced to invest heavily in the overseas market. For instance, China's non-financial foreign direct investment hit $90.17 billion in 2013. In addition, hordes of Chinese have immigrated to other countries, which is a type of private foreign investment under the foreign exchange control.

What's worth mentioning is that numerous Chinese enterprises have turned to the overseas market for survival. In 2013, among the BRICS countries, only China saw its real effective exchange rate boom, while the other four countries—Brazil, Russia, India and South Africa—witnessed depreciation.

Although China's trade surplus has continued to grow over the past few years, due to the renminbi's appreciation, its manufacturing industry has become less and less attractive to foreign investors. Now, members of the Association of Southeast Asian Nations (ASEAN) have morphed into new destinations for Chinese enterprises. In fact, many Taiwanese businesses have moved part of their production lines from China to Southeast Asian countries like Viet Nam.

Under such circumstances, it is urgent that exchange rates be exposed to market supply and demand, and that the flexibility of the two-way movement be intensified. Generally speaking, the renminbi will not maintain an upward trend in 2014.

Firstly, the unsteady nature of the global economic recovery and uncertainties brought by the U.S. withdrawal of quantitative easing are pushing the currencies of emerging countries to depreciate. Secondly, there are still risks of economic downturn in China. Thirdly, international capital may flee China because of the ongoing economic transformation and optimistic expectations for the U.S. and EU economies. Fourthly, Chinese enterprises have been severely affected by the renminbi's appreciation, and it's time to give them some breathing space.

This is an edited excerpt of an article by Zhou Zixun, an economic commentator, published in Securities Times

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