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RMB: the sooner the depreciation, the better
2016-04-18 11:34:00

RCIF | Research Center for International Finance

Policy discussion No. 2016.004
Apr. 17 2016

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RMB: the sooner the depreciation, the better

ZHANG Ming

From June 2005 to July 2015, Renminbi (RMB) appreciated 26% against United States Dollar (USD). Meahwhile, RMB's real effective exchange rate appreciated 57%. Since the second quarter of 2014, the appreciation expectation of RMB against USD in the market has been reversed to the depreciation expectation, which could be demonstrated by that the CNY-CNH spot exchange rate spread turned from negative to positive since then.

The key reason of the reversal in the exchange rate expectation is that the effective exchange rate of RMB appreciated too fast between 2013 to 2014, which could not be supported by the economic fundamentals. During that period, RMB was still largely pegged to USD, and the effective exchange rate of USD appreciated very fast due to the exit of QE and the expectation of interest hikes.
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However, if there was the depreciation pressure of RMB against USD and PBC did not allow this pressure to be released, there must be certain costs. Therefore, instead of asking whether PBC should let RMB depreciate against USD, we ought to examine whether we can afford the costs of maintaining RMB stability.
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The final cost of refusing RMB's depreciation is the negative impact of overvalued RMB to China's export growth. Although China's goods trade surplus was USD 578 billion in 2015, the reason of the huge trade surplus was not the good performance of exporting sector, but rather the very bad performance of import growth. out of the 12 months of  2015, China's export growth year over year was positive in only February and June. The weak external demand was one reason behind the dismal export growth, and the strong appreciation of RMB's effective exchange rate was another important reason. If RMB continues to remain stable against USD and USD continues to appreciate against other major currencies in 2016, China's exporting sector would continue to face downward adjustment pressure. If the pressure is too significant, both economic growth and labor market would suffer serious setbacks.
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