Weak Trade Growth Provokes Renminbi Slide

on Aug 16, 2012

An old paradigm on the financial markets states the renminbi can only go one way – up. Such canons are often disproven and this particular myth has been busted as well. The Chinese currency has weakened one per cent against the dollar since the beginning of the year. It might not seem like much from the viewpoint of other world currencies but in the case of the renminbi it is a substantial drop. The yuan has appreciated more than 30 per cent since 2005, while always being under the tight control of Beijing. On the Chinese foreign exchange spot market, the currency is allowed to fluctuate only within a range of 1 per cent from the central parity rate. The central parity rate of the yuan against the US dollar is determined each business day and is based on a weighted average of prices before opening the market.

China’s economy has been slowing down and currently is at 7.6 per cent annual expansion for the second quarter, the lowest number since the peak of the financial crisis three years ago. Traders are betting the yuan will fall even more especially with flagging external demand and low exports. The renminbi/dollar exchange rate is the most important financial metric connecting China with the rest of the world. It is also a main point of argument with Washington. US politicians blame Beijing for holding the yuan at artificially low levels for the purpose of giving its exporters a competitive edge. Presidential candidate Mitt Romney went so far as to promise he will declare China a currency manipulator if he makes it to the Whitehouse.

!m[](/uploads/story/261/thumbs/pic1_inline.png)If the renminbi continues to weaken, Beijing will have difficulties with its ambition to internationalise it. After all who would want to hold a currency that is bound to lose value? The depreciation also suggests loss of economic control and will further push China’s growth deceleration.
The weakening of the yuan did not come as a surprise and many Chinese companies stockpiled dollars at a record pace. Total foreign currency deposits in the country reached $137bn (£87.3bn), a 50 per cent increase since January.

One of China’s main concerns is the 17 per cent appreciation of the renminbi against the euro over the past year. The European Union is a leading market for China’s exports and with demand falling due to worsening crisis in the Eurozone, trading prospects for China in the region become slimmer and slimmer.
Economists believe the renminbi will either rise slightly or stay at its current levels but financial markets disagree. Traders betting on the future exchange rate are putting their money on a 1.3 per cent decrease of the renminbi against the dollar for the next 12 months. There are even more extreme predictions. Jim Walker, the same economist who predicted the Asian financial crisis in 1999, made a forecast of 5 per cent depreciation over the next year because “corporate financials in China are deteriorating dramatically”. If it was not for the People’s Bank of China, 5 per cent would have been even an underestimation, according to Mr Walker. The truth is, Beijing would simply not allow such a free fall as that would enrage US congress and possibly provoke retaliation. There are even suspicions among traders, who believe that on several occasions this year the PBoC was already forced to support the renminbi.