Why fuss over RMB depreciation?
- By He Weiwen
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E-mail China.org.cn, August 31, 2015
By December 2012, the RMB exchange rate should have already been within an equilibrium range, judging from both the current account surplus as a percentage of GDP and trade surplus as a percentage of total trade volume. However, by last month, its REER rose by 19.6% over this period, hitting the record level since January 1994, when BIS REER was first recorded, compared to the dollar's 18.8% rise. The euro, yen, Brazilian real and Malaysian ringgit all fell considerably during the same period. As a result, the RMB rose by 0.7% to the dollar, 23.7% versus the euro, 61.2% vs. the yen, 55.1% vs. the Brazilian real and 30.0% vs. the Malaysian ringgit. Apparently, RMB's REER had deviated from its equilibrium level and needed a downward correction by the market.
After the recent fall, the RMB has only depreciated to the dollar, but still appreciated considerably against other major currencies. The REER of the RMB is based on a number of major currencies, with the largest weights from the euro, followed by the dollar and then the yen. Therefore, it is impossible for the RMB REER to follow the dollar REER. The current RMB fall compared to the dollar is an issue of the dollar's strength, rather then RMB weakness, if any.
The rises and falls are daily normal in world currency markets. There is no complaint about the euro's fall. The euro could exchange for $1.46 in 2008, and $1.30 last year, but hovers currently around $1.10, with Goldman Sachs' forecasting parity by the year end. The yen fell even more against the dollar, from 83 in 2010 to a recent close at 120. Again, there is no complaint. Why a fuss over the RMB?
The fundamental explanation for the RMB's fall to the dollar is not about the RMB, because its REER is still exceptionally high, but with the dollar, which is too strong. The nominal exchange rate index of the dollar to major currencies stood at 91.6450 for July 2015, while it was 77.1141 for January 2014, or 24.5% up over 19 months. Apparently, RMB should not follow the dollar's exchange-rate level.
However, the past 42 years since the de-pegged from gold have shown the dollar's own cycles, with subsequent rises and falls. Interestingly, during an earlier 19-month period from March 2009 to October 2010, it fell by 14.0%. Again, there was no complaint from the US congressmen.
It can be anticipated that, with the FED interest-rate hike still pending, the dollar will continue to strengthen in the coming months, leaving room for the RMB to fall further from the dollar. Due to the economic fundamentals in China, the RMB's drop will be limited: It will still be reasonable if the RMB falls to 6.50-6.60 to the dollar by the year's end. However, with the dollar's strength fully developed, a new phase of dollar's fall will follow. During that period, RMB will most probably rise again to 6.40, 6.30 or even 6.20 to the dollar.
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