I’d like to come back for a moment on the Chinese currency, known as the yuan or renminbi, and its value relative to the dollar.
One of the more notable recent movements seen in the currency markets was the sharp widening in the gaps between key U.S. dollar/Chinese yuan non-deliverable forward contracts.
(A non-deliverable forward is a cash-settled, short-term forward contract on a thinly traded or non-convertible foreign currency, where the profit or loss at the time at the settlement date is calculated by taking the difference between the agreed upon exchange rate and the spot rate at the time of settlement, for an agreed upon notional amount of funds. NDFs are prevalent in some countries where forward forex trading has been banned by the government, usually as a means to prevent exchange-rate volatility.)
Last Friday, the one-month NDF showed a substantial 5 percent (annualized) revaluation of the Chinese currency, which means less yuan per dollar, while the three-month contract was predicting a 3.9 percent (annualized) move.
At the same time, we heard Chinese officials making statements that they will resist as long as they can any early move on their currency policy, completely contradicting U.S. Treasury Secretary Timothy Geithner’s recent statement that he thought “it's actually quite likely (China) will move on the their currency.”
Sunday, Premier Wen Jiabao said that “the Chinese currency is not undervalued.”
The premier, who rarely comments in public, addressed the yuan in his annual news conference at the National People's Congress, which is the highest state body and the only legislative house in the People's Republic of China.
“We are opposed to countries pointing fingers at each other or taking strong measures to force other countries to appreciate their currencies. To do this is not beneficial to reform of the renminbi (yuan) exchange-rate regime,” he said. “International pressure is not good for China's exchange rate reform. China won't bow to any pressure.”
So, do the markets get it wrong when we see the dollar-yuan NDFs falling, which implicates forecasting a rising yuan against the dollar?
For now, it’s really difficult to try to predict the near future of the dollar-yuan.
The Ministry of Commerce and the Ministry of Industry and Information Technology recently conducted joint “stress tests” in the export sectors to see how much yuan appreciation Chinese firms could withstand.
According to the initial results of the tests — which focused on textile, garment, shoe and toy exporters — every percentage point of yuan appreciation would erode one percentage point of their profit margins, which are thin because net profit margins are often only 3 percent to 5 percent.
So, this is definitively not supportive for a stronger yuan in the near future, despite the People’s Bank of China Governor Zhou Xiaochuan saying that the dollar peg is a part of a Chinese package of policies for dealing with the global financial crisis. “Sooner or later, we will exit the policies.”
The big question is of course: When is sooner or later?
We could also ask ourselves if China isn’t convinced that the global crisis is definitively over or even if they fear a double dip?
Anyway, no doubt that the second half of the year will prove critical for developed economies’ exit policies that will pose the “damned if you do or damned if you don’t” dilemma.
Withdrawing stimulus too soon could push the economies of the United States, euro zone and others back into recession, while leaving the stimulus too long would push already high fiscal deficits even higher because massive monetary and financial stimulus have already doubled public debt.
For example, the main worry now for many in the United States is runaway fiscal deficits.
The moment of truth will come when the stimulus will run out and therefore we cannot deny there is risk the economy will falter again especially in the second part of the year.
Yes, the Chinese also know that.
Anyway, it will be also interesting to see what the upcoming U.S. “currency manipulation report” due April 15 will tell us. It will also be telling what China will decide to do with its ever growing foreign-exchange reserves further down the road.
I wouldn’t expect a Chinese currency policy change in the near future. I think they will primarily continue to protect their exports.
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