Speculation has intensified that China will allow the CNY to resume appreciation. As well as a move in USD/CNY NDFs, implied options volatility has also risen. Speculation of CNY revaluation follows a significant change by China’s central bank, the PBOC to its stated FX policy in its quarterly monetary policy report last week.
The timing of the change in rhetoric should come as little surprise as it coincides with greater international calls for a stronger CNY to help rebalance the global economy as well as an improvement in economic data domestically. China has so far resisted such calls but the time may now be right for China to play its part in the global rebalancing process.
Recall that China had allowed a close to 20% appreciation of the CNY between July 2005 and July 2008 but re-pegged to the USD as the financial crisis intensified. This policy proved to be the correct one during the crisis as a stable versus appreciating exchange rate not only helped exports but helped contribute to China’s economic resilience during the crisis.
Now however, this policy is no longer needed. The worst of the crisis is over and China’s economy is doing remarkably well. Keeping the CNY artificially undervalued may stoke potential inflationary problems and distort the recovery process, whilst limiting the shift to a more consumer based economy. Managing China’s massive $2 trillion + of exchange reserves is becoming a more complicated and difficult process too. Moreover, the undervalued CNY is proving to be a global problem and hindering the adjustment of global imbalances.
Will there be an imminent revaluation of the CNY? China is in no rush to see the CNY appreciate and is unlikely to act when US President Obama is visiting. If anything, the Chinese authorities will renew the CNY appreciation trend when there is less political pressure as the last thing they want to do is to appear to be bowing to US or international pressure.
Yes the CNY is undervalued and the Chinese know this well. What is different this time is that the rest of Asia wants China to move and this is sufficient for China to act eventually but not imminently. The Chinese authorities are concerned about hot money flows and do not want to give the impression that they are embarking on an aggressive revaluation path. Gradual is the way to go but there is still room for markets to price in more appreciation next year.
What will happen during Obama’s visit is that the Chinese delegation will push for the US not to implement policies that will undermine the value of the USD especially in relation to the US fiscal deficit and the burgeoning Fed balance sheet. In return the US will push China into allowing the CNY to strengthen.
China appears to be in a stronger bargaining position given that China remains the biggest buyer of US Treasuries and the US will do little to jeopardise these investment flows. Perhaps China has pre-empted the US calls for a stronger CNY by changing the language in its monetary policy statement and it was likely no coincidence that the change happened just ahead of the US visit.