Baby steps towards full convertibility for RMB

China has been aggressively promoting the usage of RMB in international trade, preparing it for the eventual full convertibility of the currency. Besides opening access to its domestic bond market to selected foreign investors that I blogged before, it also starts to allow trading of the RMB against Malaysian Ringgit in its domestic FX market today. The Ringgit is a good guinea pig. Since China is already Malaysia’s largest trading partner, it makes sense to try to settle bilateral trade in their respective currencies rather than through the USD. On the other hand, both are effectively soft-pegged to the dollar, eliminating possibility for wild currency swings.

Separately, McDonald’s is selling $29mn RMB denominated bonds in Hong Kong. This is the first non-financial foreign entity to try this issuance. Yes, China is sticking to its game plan, that is to promote more usage of the RMB in international trade and in financial products. All these efforts eventually will lead to full convertibility a few years down the road, and challenge the USD’s role as the global reserve currency for real.

Is the RMB going to depreciate?

After reporting the highest amount of trade surplus in 18 months, and hearing an expected cacophony of calls for RMB appreciation, the spot Yuan rate has actually traded down. The dramatic fall in foreign currency loans undertaken by Chinese exporters has also indicated sharply lowered expectation for any appreciation, if at all.

According to the Century Weekly, foreign currency loans plummeted by USD5.6bn in July, on the heel of USD0.7bn and USD1.4bn declines in June and May, respectively.

Chinese exporters traditionally take out these loans to supplement their income if they expect the RMB to appreciate. The last time these loans fell was during the 7/2008-2/20009 period, at the height of the financial crisis. In fact the RMB was even expected to depreciate in late 2008.

Could this be a rerun?

Sparring of words over the RMB

All focus has been on the “unusually uncertain” comment by Bernanke, though the hearing touched on Chinese currency issue as well. As reported by Reuters:

Under questioning by one of those lawmakers, Senator Sherrod Brown, Bernanke answered “yes” when asked if he stood by a statement he made several years ago calling China’s exchange-rate policy an effective subsidy.

When pressed how much China’s yuan was undervalued, Bernanke said: “The numbers that you see in the literature range between the 10 and 30 percent range.”

As November approaches, it’s only expected that the US will push harder on this front. But are they going to get their wish fulfilled? This one is from AFP:

“The exchange rate of the currency will decline if it becomes necessary to support exports,” Zhou [Qiren, a member of the central bank’s monetary policy committee] told the Asahi Shimbun [of Japan] in an interview, according to the paper’s English-language website.

I don’t know about you, but I think Chinese exports will weaken substantially in H2 as the US non-recovery recovery sputters and European austerity kicks in. China’s own stimulus is also losing steam, so much so that the banks are quietly relenting on strict lending restrictions.  If you think China’s going to become a good Samaritan in this environment, I’ve got a bridge to sell you.

The use of nuclear option

From Reuters:

The U.S. Treasury Department again declined to label China a currency manipulator in a long-delayed report issued late on Thursday that is likely to provoke Congressional calls for tougher methods with Beijing.

So this was what all that chatter of China’s Treasury holdings as the nuclear option was  about. The blogosphere was rife with snarks of how China would be suicidal by going nuclear. But the use of nuclear weapon has always been in deterrence. NOBODY really goes nuclear, but it helps to have it to scare the other guy into cutting you some slack.

Chinese labor disputes and consumption

The AP has a nice article on the recent labor disputes, in the context of the transition of Chinese economy.

Boosting wages fits in with Beijing’s strategy of closing the income gap and promoting more equal growth in coming years, said Liu Shanying, an analyst at the Chinese Academy of Social Sciences’ Institute of Political Science in Beijing.

“If incomes won’t go up, how can domestic demand be boosted? Strikes for better pay are very much in line with the big trend of Chinese economic development,” he said.

One reason behind the more assertive work force is a shifting job market since China pumped up its economy with massive stimulus spending to fend off the global recession. Manufacturing has begun to expand into the Chinese interior, leaving traditional industrial enclaves on the coast competing for labor and giving workers a stronger bargaining position.

Workers “have the upper hand, and also sense the government is trying to address inequalities, so the workers feel more comfortable in pushing for high wages,” said Lee. [Chang-Hee Lee, a specialist on industrial relations at the International Labour Organization’s Beijing office.]

As I said before, all these are part and parcel of China’s push to rebalance its economy geographically (away from the Eastern coast) and structurally (towards households and consumption). Therefore, China is going down the path of internal revaluation rather than external adjustment via the currency. As a result, we are going to see an explosion of Chinese consumption in the coming decade. But GDP is likely to be more moderated. There already have been discussions on the viability of the current 8% “minimum growth target”. Not that China needs that high a growth rate anymore, with less people entering the workforce due to changes in demographics.

Does this mean the recent change in currency regime is nothing but a hoax? Yes if you are an exporter competing against China. But for China, this is just a necessary step towards turning the RMB into a reserve currency in the future. With substantial internal revaluation and the elimination of many export subsidies, some punters are already calling the RMB overvalued. Li Dao-kui, a member of the Chinese Monetary Policy Committee, suggested that it would take the RMB 10-15 years to be fully convertible and competitive as a reserve currency.