The Expected Unilateral Appreciation Of RMB Is Unsustainable

Facing the recent rapid appreciation of the RMB, the People's Bank of China decided on May 31 to increase the foreign exchange deposit reserve ratio of financial institutions by 2 percentage points from June 15, 2021. That is, the foreign exchange deposit reserve ratio will be reduced from the current 5% up to 7%. The market generally believes that this move is intended to regulate the supply and demand in the foreign exchange market and break the unilateral appreciation expectations.

On June 1, the central parity of the RMB against the U.S. dollar was affected by the closing price of the previous day and the exchange rate movements of a basket of currencies overnight, and continued to increase by 110 basis points. On June 2, the central parity of the RMB against the US dollar was reported at 6.3773, a sharp depreciation of 201 basis points from the previous day. Market analysts believe that the policy effect of raising the foreign exchange deposit reserve ratio has appeared, once again proving that two-way fluctuations in the RMB exchange rate are the norm.

The foreign exchange deposit reserve ratio is an important tool for the central bank to stabilize the exchange rate. In recent years, the central bank has basically withdrawn from its normalized intervention in the RMB exchange rate. 

“The central bank will not allow the RMB to appreciate too quickly, and will act decisively if necessary.” Guan Tao, Chief Economist of Bank of China Securities, said that the central parity of the RMB against the US dollar has risen by a lot since the end of May last year. If we continue to allow it to appreciate, it is possible that the value of RMB will deviate from the fundamentals. The impact of the new crown pneumonia epidemic on my country's economy has not completely disappeared, and the continued sharp appreciation may have a greater impact on related companies.

Some market participants believe that the current RMB exchange rate against the US dollar has overshooted. Sheng Songcheng, a professor at the China Europe International Business School and the former director of the Survey and Statistics Department of the People's Bank of China, said that the exchange rate of the RMB against the US dollar has been over-adjusted due to some misleading remarks recently. Zhou Maohua, an analyst at the Financial Markets Department of Everbright Bank, said that RMB exchange rate has continued to appreciate recently, and there has been a certain overshoot. From the perspective of market trends, it is largely due to excessive liquidity in the US dollar, which has contributed to market speculation.

"The increase in the foreign exchange deposit reserve ratio is mainly by affecting the foreign exchange credit expansion capabilities of financial institutions and adjusting the supply and demand of the foreign exchange market." Zhou Maohua said that recently the regulatory authorities have repeatedly voiced warnings about risks, stabilize market expectations, and moderate adjustments by increasing the foreign exchange deposit reserve ratio. Supply and demand in the foreign exchange market will help stabilize market expectations.

Lian Ping, Chief Economist and Dean of the Research Institute of Zhixin Investment, said that the adjustment of the foreign exchange deposit reserve ratio can moderately tighten the foreign exchange liquidity of the market and reduce the supply of foreign exchange funds from financial institutions to the market. This is an important indirect adjustment measure taken by the central bank in response to the appreciation of RMB.

The recent rise in the RMB exchange rate has also triggered heated discussions: some people have proposed that the RMB exchange rate should be appreciated to deal with imported inflation; some people have speculated that the central bank will abandon the goal of exchange rate stability.

In response to the trend of the RMB exchange rate, the Financial Committee of the State Council and the Central Bank of the People's Republic of China issued their voices on May 21 and 23 respectively, sending a clear signal of "maintaining the basic stability of the RMB exchange rate at a reasonable and equilibrium level." Subsequently, on May 27, the seventh working conference of the national foreign exchange market self-discipline mechanism emphasized that the exchange rate cannot be used as a tool, neither can be used to depreciate to stimulate exports, nor can it be used to appreciate to offset the impact of rising commodity prices. The key is to manage expectations and resolutely crack down on all kinds of malicious manipulation of the market and malicious creation of unilateral expectations.

"The central bank has already issued a warning to investors who speculate on appreciation, and may act decisively if necessary and take effective measures to respond. The increase in the foreign exchange deposit reserve ratio shows that the central bank must do what it says." Guan Tao analyzed that the central bank adjusted the RMB in the past. The deposit reserve ratio is generally adjusted by 0.5 percentage points each time. The increase of the foreign exchange deposit reserve ratio is 2 percentage points, which obviously exceeds the adjustment range of the RMB deposit reserve ratio in the past. The intensity is relatively large and demonstrates the determination to regulate and control.

What will happen to the RMB exchange rate in the future? Lian Ping said that although the RMB exchange rate against the US dollar is affected by changes in the US dollar index (90.1591, 0.0297, 0.03%), the basic factor or determinant of the exchange rate between the two is still the fundamental economic fundamentals of China and the United States. In the coming period, China's economic growth will remain at a medium-to-high speed level, the balance of payments will still have a double surplus, and China's interest rate will still be higher than that of the United States. A series of factors determine that the RMB exchange rate will remain relatively strong. However, a series of factors or variables may still promote the phased appreciation of the dollar and the phased depreciation of the RMB, thus forming a pattern of two-way fluctuations.

Zhou Maohua said that the deepening reform of the RMB exchange rate has achieved remarkable results. The domestic economy is recovering steadily and inflation is moderate and controllable. The FED's policy of “returning water” is the general direction. In addition, the recent domestic regulatory authorities have successively prompted risks and stabilized market expectations. It runs near a reasonable equilibrium level, showing a two-way fluctuation pattern.

"This time the central bank did not use the foreign exchange risk reserve and other common policies in the past few years, but used the foreign exchange deposit reserve ratio, a tool that was rarely used in the past. This shows that there are still many tools in the central bank's toolbox and the central bank is free to choose. There is a lot of space. In the future, if there are obvious signs of speculation in the foreign exchange market, other macro-prudential tools will continue to be launched." Guan Tao said.

Without any doubt, this is an encouraging news to the exporters in China.