Monday, 12 April 2010

Overvalued or not overvalued that is the question

The exchange rate debate rumbles on - although the pressure for an upward revaluation appears to be growing by the day, a recent FT article questions the level of revaluation required.

My prediction matches that of Goldman and Sachs - I expect something like a 5% appreciation over the next year. Not spectacular but realistic and probably enough to fend off the US attack dogs (for the time being).

Pressure mounting on China’s currency [FT]
Speculation has mounted in recent weeks about a potential revaluation of the Chinese currency. But while many analysts expect some appreciation this year, the case for a significant revaluation seems less sure.

In its March report, the World Bank raised its growth forecast for China in 2010 to 9.5 per cent but warned that tighter monetary policy and a stronger currency were needed to prevent bubbles and to damp rising inflationary expectations.

The report followed the end of the National People’s Congress when Wen Jiabao, Chinese premier, insisted the renminbi was not undervalued and warned other countries that pressing China on currency policy amounted to protectionism.

However, earlier this month, a senior government economist said China could widen the daily trading band for the renminbi and allow it to resume the gradual appreciation it halted on July 2008.

China’s currency has been effectively pegged to the US dollar since mid-2008. This, Beijing has argued, has brought stability to the international economy during the financial crisis. Recently, however, international pressure has been mounting on China to allow its currency to strengthen.

A group of US congressmen last month wrote to Timothy Geithner, treasury secretary, and Gary Locke, commerce secretary, demanding the US administration designate China a manipulator in its regular report on currency manipulation. They believe China’s refusal to let its currency appreciate is damaging the US economic recovery and hurting American competitiveness.

However, publication of the report, due in mid-April, has been postponed. Mr Geithner said there were a number of key meetings in the coming months at the Group of 20 and bilateral talks within the Strategic and Economic Dialogue with China during which he aimed to make “material progress” on China’s exchange rate and bring about a more “sustainable” global economy.

These rising tensions have not led to a radical change in market expectation of an appreciation in the Chinese currency. Indeed, markets are only pricing in a modest appreciation in the next 12 months.

“Commentators view China’s large trade surplus and rapid rate of reserve accumulation as evidence that the yuan is undervalued,” says Paul Bakunowicz, a senior foreign exchange trader at Citi in London.

“The market is predicting that in a year’s time the dollar/China rate will move to 6.6400 from the current 6.8260, which at 2.7 per cent below spot is not much of an appreciation,” says Mr Bakunowicz.

Bhanu Baweja, global head of emerging market fixed income and foreign exchange strategy at UBS, says 2010 is unlikely to be the year when Asian currencies see a material strengthening.

“People have been waiting for a 20 plus per cent appreciation in Asian currencies for a long time. We don’t think they will get lucky in 2010. The reason they have been disappointed is that foreign exchange intervention has not been very costly for central banks.

“The costs of intervention are higher inflation or higher rates. In a world of weak aggregate demand, Asian central banks are unlikely to come up against these constraints.”

A combination of sustained recovery in exports, continuation of strong capital flows and an uptick in domestic demand-induced inflationary pressures, would be the ideal setting for Asian currencies to appreciate, according to Mr Baweja. “We are looking for places in Asia which tick these boxes but there aren’t that many,” he says.

“India is one example, and we have been bullish on the Indian rupee. But consider the Taiwan dollar, which we think lies at the opposite end of that spectrum.

“It is an undervalued currency and can stay that way for a long time because there is little economic pressure on the central bank to dilute its foreign exchange intervention.”

According to UBS, the renminbi has appreciated roughly 13 per cent in nominal trade weighted terms since July 2005, when China loosened the US dollar peg. The country’s trade surplus has also fallen. But while he still believes the currency is undervalued, Mr Baweja does not believe China will feel comfortable to let its currency appreciate meaningfully, given the current economic environment.

Analysts at Goldman Sachs no longer see the currency as undervalued. They expect it will be allowed to appreciate by 5 per cent over the next year and add there is the possibility of a one-off “revaluation”.

In the past, renminbi appreciation has occurred hand-in-hand with a policy of hiking the reserve ratio requirement, says Mr Bakunowicz. The renminbi was allowed to appreciate until July 2008, when the reserve requirement ratio also peaked and the reserve requirement ratio has been rising recently, he notes.

However, despite mounting pressure Mr Bakunowicz expects China will be reluctant to allow the currency to appreciate substantially. “There will probably be gradual appreciation over time, but the likelihood of a dramatic, one-off revaluation is extremely low,” he says.

Simon Derrick, currency strategist at the Bank of New York, says Premier Wen’s annual comments are normally among the most important of the year. “It was in these closing comments five years ago that he first indicated a policy shift was likely in 2005. However, events in recent days suggest there has been a rapprochement of sorts between China and the US on a range of issues, including currency policy.

“As a result there appears to be a growing chance that China could make an initial move on its FX regime within the next few months.”

Whilst there are books on the subject things are moving so quickly that any published book is already our of date. For example, see below.




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evision said...

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online business