China – RMB at a 10% appreciation path!

We expect a 10% RMB appreciation this year, even though the non-deliverable forward (NDF) market has yet to respond in spot. The pace remains volatile, but the appreciation has accelerated after pausing at 7.0 throughout April and early May.

Capital flows surged in 1H08 and more importantly the onshore-offshore interest rate spreads remain in its favour. The latest data show that ‘hot money’ inflows may have accelerated, estimated in the region of US$300-400 billion.

As the US aggressively cut rates and China raised interest rates, the RMB quickened its appreciation. The Chinese economy is still expected to grow by 9-10% in 2008 and 2009, despite the global slowdown and a looming US recession.

While Chinese exporters are complaining about the effect of strong RMB and limited ability to pass through of production costs, but on the other hand, officials also keen to restructure the sector towards high value-added manufacturing. Exports bounced in Q2 against expectations as Chinese exporters are capturing market in Germany, Japan and the United Kingdom. Perhaps consumers are opting to buy cheaper consumer goods as fear on jobs security rises.

Amid rising concern about ‘hot money’ flows, China is adopting stricter existing foreign exchange controls, including checking for proper export documentation for FX sales. It is clear that the implied appreciation in the NDF market collapsed, but the underlying appreciation expectations have not been significantly affected thus far.