The Yuan & The Ringgit, Missing Cousins

Before the weekend, the ringgit was at 3.25 to the USD, this morning it went to 3.19. The Chinese renminbi has been effectively pegged to the U.S. dollar since late 2008, as one of the supportive policies put in place during the global recession. This peg, and the fact that it impeded other countries adjustments, has contributed to international pressure, especially from the U.S., to allow more flexibility of the exchange rate as Chinese exports rebounded.

Ahead of the G-20 meeting, on June 19, 2010, the People's Bank of China announced the intention to move towards a more flexible exchange rate regime by allowing the currency to move within a band against a basket of currencies of its major trading partners. The statement, coming less than a week before G-20 leaders meet in Toronto on June 26-27, represents a departure from a two-year period during which the RMB was effectively pegged to the dollar.

An increase in inflationary pressures and stronger export growth led market actors to expect some appreciation against the USD by mid 2010. However, the RMB's significant rise against the EUR, and thus on a trade weighted basis, could deter significant appreciation against the USD and should the EUR fall further against the USD, so too might the RMB.

Despite market expectations of a major move, any shift might be modest. Standard Chartered's Stephen Green said in the FT: "The danger is that on Monday morning everyone gets very excited and then end up being disappointed with what happens. There is very little appetite for appreciation, so in the short-term the central bank is likely to be very conservative."

The initial response to the statement has been positive, with the U.S. and European leaders lauding the decision. Dominique Strauss-Kahn, Managing Director of the IMF suggested that the move was in line with the "G-20 Mutual Assessment Process, to be presented in Toronto..., and will help increase Chinese household income and provide the incentives necessary to reorient investment toward industries that serve the Chinese consumer." The move also suggests that the G-20 will be more focused on the development in the eurozone.

Morgan Stanley's Qing Wang argues that an exit of renminbi from the US$ peg will come most likely in the Summer of 2010 (early Q3) involving a one-off revaluation of 2-3%, followed by gradual appreciation for a total strengthening of 4-5% in 2010. China is likely to exit the peg given its role in reducing imported inflation, because a free and open trade system is in China's interest, helps rebalance the domestic economy towards the non-tradable sector, and to move to a more flexible exchange rate needed for independent monetary policy. A move in July gives the U.S. administration the ability to claim successful diplomacy and Chinese to show their global responsibility before the November G20 meeting.

On April 8, 2010, the People's Bank of China sold RMB15 billion in three-year sterilization bills, the first batch since June 2008. The three-year bills are considered a more aggressive tool for managing liquidity, and may signal that the central bank is preparing to sterilize "hot money" inflows betting on RMB appreciation.

Greater CNY flexibility may lead to some initial nominal appreciation against G3. Other Asian currencies – especially those that are regarded as proxies for Chinese growth and commodity demand (AUD) - or non-FX assets in China (e.g., Shanghai A-share Index) may end up attracting greater inflows and seeing a bigger price action.

The expectation that a stronger CNY will support China’s demand for imports (including from the rest of Asia) can be beneficial for Malaysian Ringgit, Korean Won and Taiwan Dollar. Central banks across Asia may also feel a bit less pressure to stem FX appreciation in order to maintain competitiveness. The entire playbook would favour going long on the following currencies for the rest of 2010: long CNY, KRW, MYR and INR. Short the EUR and JPY. That being the case, the natural long will see a boost in financial assets in those respective countries.

Ringgit Riding On Yuan's Coattails

To those who pooh-pooh ringgit unofficial ties with the Chinese yuan, the last two weeks have showed that they were dead wrong. Palm oil futures have risen by about 23 percent over the past six months to yesterday as drier-than-usual weather in Malaysia, the second-largest producer after Indonesia, curbed yields. The U.S. dollar got smashed down against the South Korean won, Indonesian rupiah and Taiwan dollar, not to mention the yuan and the ringgit. The Malaysian ringgit, considered a good proxy for the yuan, has risen 4 percent against the dollar in the past two weeks. The Indian rupee has gained 3 percent.



A firmer ringgit yields more benefits to Malaysia than the things we lose out on competitiveness.

The ringgit strengthened 1.8 percent this week to 3.1900 per dollar in Kuala Lumpur, according to data compiled by Bloomberg. It reached 3.1860 yesterday, the strongest level since May 2008. India’s rupee climbed 1.4 percent to 44.2938 and South Korea’s won appreciated 0.7 percent to 1,118.15.

Equity funds focused on developing economies attracted $3.27 billion in the week to April 7, taking net inflows for the year to $10.8 billion, according to Cambridge, Massachusetts- based research firm EPFR Global, which tracks funds with $13 trillion of assets globally. The Asia Dollar index, which monitors the performance of the region’s 10-most active currencies, climbed 0.6 percent this week.

April 7 (Bloomberg) -- China is considering allowing the yuan to trade against the Russian ruble, South Korean won and Malaysian ringgit to promote its use in cross-border trade, an official at the China Foreign Exchange Trade System said.

The People's Bank of China is investigating the possibility of offering new currency pairs, said an official at the Shanghai-based interbank exchange, a subsidiary of the central bank. He asked not to be identified as authorities have yet to make a final decision. Traders now can buy or sell the yuan against the dollar, the euro, the yen, the Hong Kong dollar and the British pound.

China is seeking greater use of its currency to reduce reliance on the U.S. dollar after Premier Wen Jiabao said last month he is “worried” about holdings of assets denominated in the greenback. From July, the government started allowing companies in Shanghai and four cities in the southern province of Guangdong to use yuan in cross-border trade with Hong Kong, Macau and members of the Association of Southeast Asian Nations.

President Barack Obama will keep pressing China to end the yuan’s 21-month-old peg to the dollar and may bring up the topic when he meets Chinese President Hu Jintao next week, spokesman Robert Gibbs said yesterday. Executives at Chinese banks have backed a stronger currency to allow it to play an increased role in global trade and spur growth in financial markets.

China’s currency has been held at around 6.83 to the dollar since July 2008, after appreciating 21 percent in the previous three years. Twelve-month non-deliverable forwards traded at 6.6355 per dollar, reflecting bets the currency will climb 2.9 percent from the spot rate of 6.8254 in the coming year.

U.S. Treasury Secretary Tim Geithner last weekend announced the postponement of the April 15 deadline for an annual foreign-exchange policy review, which may have resulted in China being labeled a currency manipulator. He said meetings over the next three months will be “critical” to bringing policy changes that lead to a more balanced global economy.

“They’re becoming more open to the world, and with that, you’re going to see the currency take on a broader role internationally,” Geithner said in an interview with Bloomberg Television to be aired today. “That’s a healthy, necessary adjustment.”

Expectations that China’s currency will appreciate drove yuan trade settlements to 7 billion yuan ($1 billion) in the first two months of this year, almost twice the 3.6 billion yuan in the second half of 2009, Zhang Yanling, vice chairman of Beijing-based Bank of China Ltd., the nation’s biggest foreign- currency lender, said in a March 19 interview.

“If the yuan is expected to be a strong currency, neighboring countries will prefer to hold the yuan instead of the dollar,” she said.

Since December 2008, China has set up 650 billion yuan worth of swap agreements with Indonesia, Malaysia, South Korea, Hong Kong, Belarus and Argentina, broadening access to the yuan. The central bank has also proposed expanding the use of International Monetary Fund depository receipts in reserves instead of dollars.

“They’re trying to encourage yuan trade settlement, so it would make sense to commit to more trading pairs,” said China chief economist at Royal Bank of Scotland Group Plc. “It would be a natural part of the growing convertibility of the yuan and a step towards widening the use of the yuan. Convertibility of the yuan is a long-term change, but China is taking all the right steps.”

China’s dollar purchases to maintain the currency link have driven currency reserves to $2.4 trillion. Chinese investors held $889 billion of Treasuries in January, the biggest overseas holdings of such debt.

Geithner Could Label China As A Currency Manipulator Come April

The Greek debacle has been dying down a bit after attempts by bigger EU nations to placate the markets. While the Greece situation is still dicey, it is still in ICU but showing signs of life and recovery. Now we have a new looming "bear factor" coming to play with a fixed deadline, mid-April.



There have been furious behind the scenes negotiations that have basically gone nowhere. Now the discussions, opinions and grouses are being publicly aired - obviously after the secretive discussions went nowhere, the US BSDs will have to air their attempts to the democratic Senate, telling them that they have tried. Just weeks before he makes a decision whether to label China a "currency manipulator," which could trigger tougher action against Beijing, Geithner said last week that Beijing should allow its yuan currency, which is virtually pegged to the US dollar, to appreciate in a reflection of market expectations.

"We can't force them to make that change. But it is very important that they let it start to appreciate again," he said.

Some experts believe the Chinese currency is undervalued against the dollar by up to 40 percent. The United States and China's other trading partners claim that it gives the Asian giant an unfair trade advantage by making Chinese exports cheaper. US lawmakers have called on Geithner to label China a "currency manipulator" in a mid-April US Treasury report, as they demanded Beijing to revalue the yuan.

The exchange rate is the most important factor in determining U.S. export competitiveness. Every increase of 1 percent in the dollar, averaged against other major currencies, reduces US exports by about $20 billion annually and destroys about 150,000 jobs. The recurrent overvaluations of the past 30 years, when the dollar became overpriced by 30 to 40 percent, contributed significantly to the decline in manufacturing jobs and was the major cause of the huge current account deficits of most of that period.

The policy goal should be a competitive exchange rate that produces a sustainable trade balance, rather than a "strong dollar." Fortunately, the decline of the dollar since 2002 has virtually restored equilibrium in its value against most other industrial countries' currencies.

Fred Bergsten said that the remaining large misalignment is the undervaluation of at least 25 percent of China's renminbi and the currencies of several important economies surrounding it (Hong Kong, Malaysia, Singapore, Taiwan). How to make a correct statement but with all the wrong examples. Yes, the HKD is undervalued but its not their active manipulation that causes that, OMG its been pegged to the USD for 20 years - if anything it just shows that HK has been a lot more competitive and productive using the same currency.

Singapore is not overvalued, if anything they have let their currency to appreciate as they wanted to be progressive and hive off the labour intensive industries. So Fred's very wrong there. As for Malaysia, well he is right on the dot. As much as the yuan is undervalued, Bank Negara has been keeping the ringgit in step with the yuan for the past 5-7 years. BN is more concerned on pricing Malaysia's industrial competitiveness rather than letting the ringgit appreciate on its own. Taiwan's currency is also slightly undervalued but nowhere as much as the ringgit. Of in my view, if the yuan is 40% undervalued to the USD, the ringgit is about half that.

If China continues to block any rise of the renminbi, the administration should label it a currency manipulator and escalate pressure, including by taking China to the World Trade Organization.

Obama has entered into negotiations for a Trans-Pacific Partnership with seven Asia Pacific nations, a group that could shortly expand to include a critical mass of countries in that region and eventually evolve into the Free Trade Area of the Asia Pacific that President George W. Bush proposed in 2006. The administration should aim to conclude these talks when the United States hosts the annual summit of the Asia-Pacific Economic Cooperation forum in 2011.

The Obama's administration should abandon its plan to increase taxes on the overseas activities of U.S. firms because their foreign investments clearly increase U.S. exports. Several modest tax reforms could enhance our international competitiveness, including to attract direct investment here by foreign companies that would then access many of their global markets from the United States and create jobs here.

The administration and Congress must avoid hurting U.S. competitiveness when they inevitably move to raise tax revenue substantially over the next few years to help curb the budget deficit. Increases in corporate income tax rates would jeopardize exports by raising U.S. production costs. By contrast, a value-added tax or national retail sales tax, or better yet a gasoline or carbon tax, could be fully rebated at the border on exports (and imposed at the border on imports) and thus avoid such harm. Positive export and job expansion would be fostered by replacing some or all of our current income tax system with these alternative devices.

In the past a rising renminbi hasn’t reduced China’s surplus, the United States can’t produce many of the goods it now imports from China, so most of the jobs won't get shipped back even if the yuan is revalued 20%. In many cases, Chinese exports compete with those of other developing nations. If the renminbi rises, those nations would become more competitive – and would also find their currencies appreciating against the dollar, offering new channels for onshoring.
China is an economy in the process of rapid transformation – exactly the circumstances in which a real exchange rate that makes sense one year may be way off base just a few years later.

The U.S. administration feels that the policy of keeping quiet on China and instead engaging its leaders privately has failed. The U.S. grudgingly accepted for a while that China was bound to re-peg in the middle of the economic and financial storm of 2008-09 as it was rapidly losing exports and experiencing a sharp growth slowdown.

A formal U.S. statement that China is a currency manipulator would not trigger automatic U.S. trade sanctions against China; rather, it would lead to a negotiation process that bilaterally—or possibly multilaterally with the IMF—would rectify the situation. Trade sanctions would be the eventual outcome of failed negotiations. In fact, it could take the better part of a year for disputes to be lodged with the WTO and trade sanctions imposed. But certainly even a formal U.S. statement that China is a currency manipulator would significantly raise trade tensions and nervousness in financial markets about a trade war.

The real-estate boom is turning into a bubble, with home prices rising more than 32% in the largest cities in the last year alone. Ghost towns are popping up all over China as the increase in the supply of commercial real estate, with vacancy rates in office space of 20% in Beijing and 16% in Shanghai, and of residential real estate, especially at the high end of the market, is becoming serious. Even in infrastructure, China has advanced too far for a country at its level of development, as evidenced by empty highways to nowhere, bullet trains that no one uses and fancy, empty new airports.No country in the world is productive enough to take almost 50% of GDP every year, reinvest it into more physical capital stock to produce more goods and services and not end up with a glut of capacity that will eventually cause low returns, rising nonperforming loans and rising implicit liabilities for the public sector.

Letting the currency appreciate is key for achieving the stated goal of increasing consumption's share of GDP.The financial market consequences of such a move could be significant: If the decision is unexpected, global stock markets could fall by several percentage points once the ugly M word is uttered by the U.S. Treasury. And so far, financial markets don’t seem to be pricing in such an outcome. History suggests that even threats of trade protectionism can sharply move financial markets. Take 1987: The U.S. had a very large current account deficit, in spite of the dollar falling since 1985, and the major U.S. trade partners (Japan and Germany, which were running a large surplus with the U.S.) were resisting the U.S. push for further rapid appreciation of their currencies against the U.S. dollar. On a Sunday morning, as tensions were rising, then-U.S. Treasury Secretary James Baker appeared in a TV interview and implicitly threatened a trade war if Germany and Japan were to resist further appreciation of their currencies. The next day, the Dow Jones index fell by 20% in the infamous October 1987 stock market crash.


p/s photos: Ju Daha