RMB - On a Secular Appreciation Path

Over the last five weeks, I have been constantly bombarded with questions on China’s currency. About a year ago, I wrote a piece on Renminbi (RMB) outlook for one government agency and I argued that the currency is on a secular strengthening mode, pretty much like Japanese Yen after the Plaza Accord. However, with the recent global volatility, equity burst, contraction in property market in China and more importantly rising dependency on exports, some of my loyal clients to a great extent, have been persuaded not to subscribe to my earlier view.

For once and all, I still maintain my view that RMB is on a secular appreciation path, and the recent sell-down in the currency is not only a trading, but a great opportunity to build for a long term position in China.

Let us be very clear here – Firstly, what we are seeing today in China is a recession in demand and not peer competition that is creating a pressure on exports. Secondly, China is very unlikely to go into recession and my worst case projects above 6% for 2009. Thirdly, I put my bigger bet on the effectiveness of China’s fiscal policy in cushioning the global shock compared to a lot of economies that I monitored. China enjoys plenty of fiscal flexibility as both government and households maintain a high saving rate. Fourthly, RMB is not fundamentally overvalued even if I assumed the trade surplus to ease by 20% from current level in 2009.

Devaluing RMB will be a no-no for assets and market confidence. Risk of domestic capital flight can materialize, hence complicating monetary expansion, which has been partially a reflection on expectation of RMB appreciation. The competitive devaluation will invite trade retaliation from the US and EU as well as major emerging economies, which in turn will intensify pains to already shrinking global market. It also defeats and nullifies all efforts by the Chinese government in the last decade in areas of financial, economic and diplomacy coordination.

The latest CCCP annual economic meeting on 10 December has reiterated that the view to ‘keep RMB basic stable at fundamentally justified equilibrium level, improve balance of payment’ and on 14 December, the state council’s financial statement called for ‘proceeding in proactive, incremental and controlled mode; further improve RMB exchange rate regime, increase flexibility ..’

The government set 15-17% yoy M2 growth, RMB4 trillion new lending for 2009 and a stable exchange rate to reflect government’s strong commitment of clear re-flationary intent.