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Worries persist over continued, long-term, structural currency appreciation in China

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The recent fixings of the People’s Bank of China (PBoC) caused the Chinese Renminbi to depreciate one per cent over one week. This has raised worries about the forecast of a continued, long-term, structural currency appreciation in China, says Asoka Wöhrmann, Co-Chief-Investment Officer at Deutsche Asset & Wealth Management (DeAWM)…

There are two potential motivations behind PBoC’s recent behaviour: On one hand, the PBoC’s fixing could indicate a change in the monetary policy due to concerns about GDP growth and competitiveness. On the other hand, the depreciation could be driven by the PBoC’s attempt to stem speculative inflows into China.

The first assumption, a change in monetary policy to bolster growth, is not very likely as China has no recent history of using monetary policy to counter growth or export weaknesses, not even during the Asian Crisis 1997 or in 2008/2009. In fact, there is no need for an export stimulus as China’s export have recently grown the most within Asia.

More plausible is the second assumption of the attempt to stem speculative inflows. The inflows of speculative capital, also called hot money, have increased sharply since late summer 2013 when bond and money market yields rose significantly. As the Chinese money and bond market rates are expected to stay relatively high, the PBoC is concerned about further inflows. The exchange rate is the instrument at hand to cope with speculative capital in the short term. And the countermeasure appears to bear fruits: Speculative capital is already leaving the country.

We expect the long-term appreciation trend to resume at a gradual and modest pace and remain a key tool for re-balancing the Chinese economy towards more sustainable growth. However, the upward trend will materialise with more short-term volatility in order to give a disincentive for short-term speculators.

As a precursor to further FX liberalisation, we may see a band widening – likely 1% to 2% – in Dollar-Renminbi in the coming months. Hence, we should see volatility in Dollar-Renminbi with movements into both directions going forward.

Further reform details are to be unveiled during “China's 12th National People's Congress (NPC) which will commence its second session on 5 March 2014. Most likely, reforms and financial market and other liberalisation remain a key focus. We expect the uncertainty about the future currency direction to fade by then.

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