About a month ago, the People’s Bank of China (PBOC) surprised market participants by modifying the renminbi’s daily fixing, a move that decreased the currency’s value by about 4.4 percent.
This policy shift occurred three days after July export data indicated that outgoing shipments of Chinese products had declined 8.3 percent from year-ago levels.
A press conference hosted by the PBOC on Aug. 13 failed to clearly explain the rationale for changing the renminbi’s daily fixing mechanism.
Given this announcement’s proximity to the release of disappointing trade data, the market interpreted the renminbi’s devaluation as a sign that the PBOC had sought to stimulate exports because the Mainland economy was headed for a hard landing.
But this reading of the renminbi’s devaluation ignores the severe downdraft in the price of crude oil and other commodities—a much bigger tailwind for Chinese exports than a slight reduction in the value of its currency.
Lower commodity prices help to explain why China’s monthly trade surplus remains a few ticks away from of its 15-year high of US$60.62 million. And through the end of August 2015, the country’s cumulative trade balance stood at US$365.5 billion, putting the Mainland economy on track to eclipse last year’s surplus of US$382.46 billion.
In reality, this initial step toward a market-determined currency likely reflects Beijing’s push to persuade the International Monetary Fund (IMF) to classify the renminbi as one of the world’s reserve currencies.
The day that China changed the protocol for the renminbi’s daily fixing, the IMF applauded the move as “a welcome step” toward “allow[ing] market forces to have a greater role in determining the exchange rate.”
The IMF’s statement also asserted that China could achieve a floating exchange-rate system over the next two to three years. According to the IMF, “a more market-determined exchange rate would facilitate SDR [Special Drawing Rights] operations in case the renminbi were included in the currency basket [a reserve asset] going forward.”
Today, the IMF’s basket of reserve currencies consists of the euro, Japanese yen, British pound and US dollar. The IMF will complete its review of the SDR components by the end of the year and begin implementing any changes at some point in 2016.
Our outlook calls for China to limit the renmimbi’s devaluation to no more than 5 percent annually, as a weaker currency would undermine efforts to pivot the Mainland economy toward domestic consumption. This evolution will take place over a longer time frame and involve intermittent growing pains.
As part of this transformation, China’s producer price index, which measures wholesale prices, has been locked in a steady downtrend for three years and real interest rates have remained elevated.
Although China’s economic growth rate has slowed, the service sector’s contribution to gross domestic product (GDP) has increased to 48.2 percent. This trend has continued through the first six months of 2015, with the service side of the economy growing by about 8 percent and manufacturing and construction growing by 6 percent.