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For more than a decade, China’s currency, the Renminbi (RMB), had been on a path of appreciation, but some weakness this year generated renewed talk about whether the currency is fairly valued against global currencies. As global equity investors, we are constantly faced with currency changes. This is an important factor when considering our investments, because currency movements impact companies’ earnings and operations. Of course, there are winners and losers with currency ups and downs. Export-driven companies can thrive with weaker national currencies, while domestic-driven industries are more likely to suffer. As one of the world’s global export powers, China has kept tight controls on its currency in order to enhance its investment and trade position, but those controls are starting to loosen.
Names and Places
Currency dynamics can be confusing, and there is a lot of confusion just in the differences in the Chinese currency names of RMB, CNY and CNH. To clarify, the People’s Republic of China dubbed its official currency the “Renminbi” in 1949.”Yuan” is the name of a unit of the Renminbi currency and is called one of two things depending on whether there is onshore or offshore use: CNY is in reference to RMB onshore in China (hence the “Y”), whereas CNH refers to RMB outside the China market offshore, primarily in Hong Kong (hence the “H”). Due to the effective segregation of the onshore/offshore RMB markets, CNY and CNH can often be subject to different demand and supply factors.
It’s also important to note that while the name Renminbi means “the people’s currency,” the short name for the RMB or Yuan in China is also called the “kuai” (literally means piece). Spoken with a different tone (tones in Chinese language are very important since the meaning can change dramatically with a different tone) “kuai” can also mean fast. And now it seems that pressure on the RMB’s convertibility is accelerating even though China’s central bank (the People’s Bank of China or PBOC) has suggested it would prefer to slow things down for a more prolonged transition. China is the second largest economy in the world and if it is destined to potentially become the world’s largest economy—which I believe it is—they will need to match that size with a position in currency leadership.
To lessen its dependence on the U.S. Dollar and gain entry into the International Monetary Fund’s currency basket, the Chinese government has indicated that they would like to make the RMB fully convertible on the international stage by 2015 (which some say is a bit overly ambitious especially given the current global environment), and has increased the use of the RMB in international trade and investment.
Hong Kong was the first location outside mainland China with an interbank market for RMB, therefore known as the “Offshore RMB Centre.” Banks there have been encouraged to offer limited services and products denominated in Yuan, including so-called “dim sum” bonds which can be viewed as a step toward broader currency convertibility. Offshore RMB trading is also sanctioned and regulated in Macau. At the end of August, the PBOC announced a RMB clearing bank would also be set up in Taiwan. The creation of new offshore centers has been a key policy focus for some time, and there’s speculation London, Dubai and Singapore could also be potential destinations for offshore RMB markets.
Our research indicates that the RMB is undervalued against the U.S. Dollar at this time, but not by much. And, in the past month, there has been a rebound. Don’t forget China has had many years of double-digit economic growth over the past three decades, while its trading partners have been slower-growing. During the last 18 years, the RMB has appreciated by roughly 30%, but that does not seem to be enough for the global community given the fact that China now has the world’s largest horde of foreign exchange reserves (more than USD $3 trillion1) and continues to accumulate current account surpluses as well as record foreign investment inflows.
China seems concerned about the consequences of currency appreciation, but perhaps a page can be taken from Japan’s currency book. When I was living in Japan 35 years ago, I could exchange 360 yen for one U.S. Dollar. The currency was floated in 1973, and decades later, the exchange rate is now roughly yen 78 per USD. Exporters in Japan were worried that the strengthening currency would result in disastrous export competitiveness, but it didn’t happen. What did happen is that Japanese companies upgraded technology and quality, exactly what the Chinese are now doing. However, to truly become a global reserve currency (and perhaps avoid some of Japan’s subsequent economic missteps), China needs further fundamental and structural changes, including the opening of its financial markets.
While I believe China could become the world’s largest economy someday, I don’t think it’s likely to overtake the U.S. Dollar as the world’s reserve currency anytime soon because of the current restrictions on the exchange of RMB. I see that as a more distant-future possibility aided by a free-floating currency; international market growth in the nearer term seems more likely. Currently, the PBOC fixes a reference rate for the currency and limits gains or losses to a specific daily percentage from that reference rate level. Loosening the reins on the currency could cause its record foreign-exchange reserves to drop in its defense, but in my view, this is just yet another key transition in an economy that is going through many structural changes in working toward its goal of having a strong future as a world leader.