NEW YORK (ResourceInvestor.com) — China in 2005 sounds a whole lot like Japan a decade earlier except the fracas this time is over monetary rather than trade policy. The value of the Chinese yuan, also known as the renminbi, has become critical to commodity fundamentals as well as equity valuations for companies targeted by China for acquisition.
China’s Prime Minister, Wen Jiabao, has made it clear that the value of the renminbi will be dictated by domestic requirements, not foreign pressure. However, Wen also reaffirmed the commitment to liberalizing the foreign exchange regime in time.
Given Wen’s statement, Mitsui Global Precious Metals made a timely call against prospects for revaluation. Analyst Andy Smith noted last Friday that there was no reason to change the peg which has worked well for China from any perspective.
There has been feverish speculation about the timing of a renminbi revaluation. Some Hong Kong banks have reported a doubling of renminbi placed on deposit compared with last year. Speculative purchases of the currency in anticipation of a revaluation have also fuelled China’s loose credit conditions, creating concern about malinvestment in basic industries. Investors have also been buying real estate in the major cities to take advantage of an expected change in the peg with the dollar sometime this summer.
Wen’s comments have raised the possibility of a split among senior party officials. In April, Zhou Xiaochuan, the head of China’s central bank, said that China was cognisant of foreign concerns about the value of the renminbi. However, last week he said no revaluation would take place on May 18 when some forex liberalization takes effect.
However, investors should be warned against over-interpreting the differing statements since government officials habitually use the state media to float and shoot down trial balloons.
Romeo Dator, Portfolio Manager for the U.S Global Investors China Region Opportunity Fund [USCOX] told Resource Investor that he remains confident that China cannot avoid revaluation. He ascribed Wen’s announcement to a desire to constrain speculation and tee up the “surprise” China has been alluding to.
He also said that Chinese producers are being squeezed by soaring commodity prices. A stronger renminbi would provide some much needed margin relief for Chinese industry, which Dator also expects to buttress commodity demand.
China has fixed the value of the renminbi at 8.28 to the U.S. dollar since 1994, which was a masterstroke that ignited the economy, produced low inflation, and sucked in billions of dollars from manufacturing exports. China’s balance sheet boasts foreign exchange reserves of nearly $700 billion.
The United States has been leading the campaign for China to revalue the renminbi as the preferred mechanism to address trade imbalances. The US is now set to impose tariffs on certain Chinese textiles.
Also, markets are waiting on the US Treasury’s semi annual report assessing the exchange rate policies of major trade partners. There is some speculation that China might be cited for manipulating its currency to gain trade advantages, though Japan is a much bigger culprit with its huge forex market interventions.
Intriguingly, Wen described China’s currency management regime as “following the rules of a market economy” though the renminbi does not float free.
Analysts are betting that until the excessive percentage of non-performing loans is cured, and pall mall credit extensions are curbed, China is unlikely to fiddle with the currency for fear of collapsing the financial sector. Similarly, the politicians are all too aware of the need to avoid a shock to the factories that provide employment and dollar earnings.
At the same time China has no desire to harm its rising power in the region. Many countries have become dependent on selling goods and services to China, which are in turn repackaged for export. Any revaluation would have a strong regional knock-on effect.
Wen’s pronouncement may have been driven by a JP Morgan report suggesting that fundamentals demanded a revaluation. The firm speculated that an incremental revaluation might commence this year, starting with a 3% appreciation.
A good deal of store is placed in per capita Chinese gold consumption. However, the numbers show that Chinese gold demand has been insignificant relative to GDP growth. Mitsui’s Smith noted cynically: “Reduced inflation and growth volatility have helped kill Chinese gold demand this past decade: directly by reducing the ‘fear’ motivation for hoarding [and relaxing the Chinese enough to splurge on luxuries, like platinum and plumbing]; indirectly by stimulating an above ground financial system that has disappeared gold’s market share of savings.”
The counterpoint is that China may rejig its reserve portfolio to have more gold and less dollars.
By Tim Wood
Source: ResourceInvestor.com
Photo credit: Stanley Zimny (Thank You for 22 Million views) via Visual Hunt / CC BY-NC
Leave a Reply