The Rupp Report: Rollercoaster Chinese Currency

For decades the saying was: “If the United States has a cough, the world has pneumonia.” These times are over, definitely. Today, the saying is more like “If China lifts an eyebrow, the world is in trouble.”
This saying also holds true for the global textile machinery industry. Taking the increasing importance of the Asian markets into consideration, in 2001 the first ITMA Asia took place in Singapore and was a perfectly organized event. After the second event in 2005 — again held in Singapore — China took over, literally. The Middle Kingdom became such a power that it convinced the European Textile Machinery Manufacturers Association (CEMATEX) to organize an ITMA Asia every two years in, of course, China. This despite an annual Shanghaitex (See “The Rupp Report: Shanghaitex: Too Much Or Not Enough?”), and at a much lower overall quality than in Singapore, for whatever reason. However, in many discussions and interviews with the leading European textile machinery manufacturers, it was declared that sales to China are generating more than 50 percent of total turnover.
Good Start In 2015
Usually, the Rupp Report doesn’t comment any type of political influences or trends, for example. However, something unexpected happened that no one in the international economy, including the global textile machinery industry, anticipated.
Some governments recorded the growth of the Chinese economy in the first quarter of 2015 to be “only” 7 percent; indeed proof of a solid economy. In this figure, the growth of energy intensive and polluting products decreased, while on the other hand, services increased and are today the driving force of the Chinese economy. Also the domestic market is growing, as the government predicted some time ago. Domestic retail trade grew over the past year by 10.8 percent, not forgetting the Internet sales — this sector increased by more than 40 percent
Unexpected Move From China
Last Tuesday, the People’s Bank of China (PBoC) “reformed the exchange rate mechanism to better reflect market development in the exchange rate of the Chinese renminbi (RMB) against the U.S. dollar.” The move surprised the market and prompted the lowest valuation of the RMB since October 2012. The central parity rate of the RMB against the U.S. dollar weakened by 1,136 basis points on Tuesday and further dropped 1,008 basis points on Wednesday.
Though, the PBoC declared on Wednesday after the sharp decline that, “the central bank is fully capable of stabilizing the exchange rate through direct intervention in the foreign exchange market to avoid herd mentality leading to irrational movements of the rate.”
With this move, China is somewhat emancipating itself from the United States. The reason for this is because the RMB is strongly pegged to the U.S. dollar, which provoked the Chinese currency to act heavily in view of a strong U.S. currency in recent months. In fact, the effective exchange rate against its major trading partners of China in the second quarter 2015 compared to the same period last year is 14 percent higher. But let’s start at the beginning …
How It Works
The central parity rate of the RMB against the U.S. Dollar is based on a weighted average of prices offered by market participants before the opening of the market and also refers to the closing rate on the previous day, in conjunction with supply and demand and the movement of major currencies.
After the first reduction, China’s central bank stated that it will continue to be active, but only in case of extreme volatility in the currency market. The next day, China’s central bank intervened with $20 billion in order to stabilize the exchange rate of the RMB against the dollar — officially — without expecting a further weakening of the RMB. China’s central bank sits on a lot of money and its foreign exchange reserves are estimated around $3651 billion.
However, the rollercoaster moved again. On Thursday, the RMB lost against the dollar. The official website of the Chinese government stated: “The Chinese currency continued its sharp fall for a third consecutive day on Thursday (August 13) after the central bank reformed the exchange rate formation system.” The central parity rate of the RMB weakened by 704 basis points, or 1.1 percent, to 6.401 against the U.S. dollar on Thursday, according to the China Foreign Exchange Trading System. The central bank fixed the exchange rate on Thursday with RMB 6.4010 per dollar with the possibility to fluctuate during the day ± 2 percent.
Positive Feedback
Both the International Monetary Fund (IMF) and the Asian Development Bank (ADB) rated this move to be positive. Officially, the RMB is indeed linked to a basket of currencies, but de facto it is dominant with a share of more than 90 percent on the U.S. dollar.
The developments in China currently worry entrepreneurs and investors very much. A lot of questions remained unanswered: Is China’s economic growth coming to an abrupt end and a major driver of the global economy will standstill? What is the outcome of the strong slump on the Chinese stock market? And finally, could the way under the recently initiated reform of the exchange rate lead to an anticipated currency war from China?
The Way To Normality
Calming fears was a message from the International Monetary Fund (IMF). In an article published on Friday evening countries report, the IMF stated that the recent incidents were mainly normalization. The IMF said the slowdown in economic growth would be merely a development towards a new normality with a matured national economy and the slump in the Chinese stock market is nothing more than a correction, analysts said. The IMF sees that the stock market neither emanates any systemic risk or that the price correction would have an impact on the economic growth of the country.
Midweek, the IMF welcomed on Friday evening once again the reform of the exchange rate fixing. The PBoC announced earlier this week that in the future they would take into account also the closing price of the previous day in the determination of the exchange rate. This would expose the RMB market forces in a more prominent way and the exchange rate has a larger fluctuation potential. This would be a significant step towards a flexible exchange rate policy, says the IMF. This position could be reached by China in two to three years, which would be of enormous importance for the country. One must know that China, because of its permanent opening, is increasingly dependent on an independent monetary policy, which is not possible with fixed exchange rates and capital controls.
Currency Basket Of Special Drawing Rights
Experts say with the chosen path, the central bank has opted for a market-oriented solution, which should be regarded as a further argument for the inclusion of the RMB in the basket of Special Drawing Rights (SDR). China’s government is located, despite this devaluation, in a comfortable situation. SDR is a kind of global currency, whose exchange rate is leveled and interlinked with the U.S. dollar, the euro, the British pound and the Japanese yen.
Theoretically, the RMB can now gain or lose 2 percent in value every day. This would result in a variation of around 10 percent per week, so that one could speak in a certain way of a floating exchange rate. The IMF, however, is now standing by to see how accurately the PBoC will carry out the announced currency reform and how the daily rate will actually set daily.
Hidden Export Promotion?
The RMB has lost 2.9 percent this week against the U.S. dollar. Because this will cheapen Chinese products for buyers from abroad, in some parts of the world or competitors suspect that China is operating a hidden monetary policy through export promotion or is even trying to instigate a currency war. However, in previous years, the RMB had strongly increased in value against the U.S. dollar. At the moment, not many people know if the rollercoaster for the RMB will continue. Time will tell, and the global textile machinery community is hoping that the rollercoaster will soon stop.

August 18, 2015