Practical analysis for investment professionals
10 July 2017

The Renminbi: Don’t Bet on a Big Plunge

China’s financial system is supposed to collapse under the weight of nonperforming loans (NPLs) in 2017.

This implosion will be driven by the country’s excess industrial capacity and runaway lending, spurred by the proliferation of shadow-financing-related wealth management products.

China’s economic growth, in turn, will plunge, leading to monetary easing, capital outflows, and a further decline in China’s currency, the renminbi (RMB), against the US dollar.

Goldman Sachs recommended a short position in the RMB as one of their “top trades for 2017.” The firm’s 2017 year-end target for the US dollar/RMB exchange rate is 7.30. As of this writing, the onshore rate is trading at 6.80, 7% above Goldman’s target. The lower the rate, the stronger the RMB is relative to the US dollar.

Global macro trader Kyle Bass has been predicting a 30% devaluation of the RMB since January 2016. The prevailing bearish sentiment on the RMB has decreased somewhat over the past few months, however, as other macro and political events have distracted investors.

Due to the inherent volatility in the currency markets, the RMB may fall by another 5% to 10% relative to the US dollar by the end of 2017, especially if the US Federal Reserve follows through with its three promised rate hikes.

But those betting on a bigger plunge are fundamentally misguided.

The RMB will hold steady against the dollar for the rest of 2017. Here are three reasons why:

1. China’s policy has promoted stability.

The chart below chronicles changes in the US dollar/RMB exchange rate over the last 20 years along with the major policy events that have affected it.


From January 1995 to July 2005, the US dollar to RMB exchange rate traded in a narrow range, with an average of 8.28 RMBs to the dollar. Throughout the Asian financial crisis and the ensuing currency devaluations in Southeast Asia in September 1997, the People’s Bank of China (PBOC) officially pegged the RMB at 8.28 when many expected China to devalue to boost exports.

Many analysts have forgotten this important piece of financial history. When all of China’s export competitors devalued to boost their trade balances, China steadfastly held to its 8.28 peg, thereby ceding export market share to its Asian neighbors. It was a signal to the world that the RMB has value and that China is an economically responsible neighbor.

During the global financial crisis, China’s policy makers pegged the rate at 6.83 even as the US dollar surged and many of the country’s export competitors devalued. China then announced a $586 billion stimulus package — equivalent to 13% of the country’s gross domestic product (GDP) — to jumpstart global economic growth. Infrastructure investments made up nearly 40% of the package, which was implemented in just two years due in large part to the broad availability of shovel-ready projects across China.

More recently, as part of its long-term efforts to shift to a more market-based exchange rate, the PBOC announced a new dollar/RMB fixing mechanism that was more reflective of FOREX dealers’ expectations and changes in major currency exchange rates. In conjunction, the PBOC orchestrated a one-time 1.9% devaluation of the dollar/RMB exchange rate to:

  • Reflect recent US dollar strength at the time, particularly relative to emerging market currencies.
  • Pave the way for a more aggressive easing of monetary and fiscal policy.
  • Discourage speculative flows that have benefited from the RMB “carry trade” through long positions in RMB-denominated deposits in Hong Kong or Chinese corporate borrowing in US dollars.

From the PBOC’s perspective, the one-time 1.9% devaluation rate made logical sense and was deemed a minor issue. But the PBOC did not anticipate the negative reactions, including renewed critiques of China’s mercantilist policies along with heightened volatility in global financial asset and commodity prices.

While China’s policy makers expect some depreciation in the RMB as speculators and China’s corporations unwind their RMB carry trades, the notion of a significantly larger —30% or greater — devaluation by the PBOC is farfetched.

China has stuck to a currency peg at the expense of its own global export market share during two critical moments for the world financial system: the 1997 to 1998 Asian financial crisis, and the global financial crisis. Why would China’s policy makers consider a large devaluation, especially given the country’s ongoing comparative advantages in trade, an improving net international investment position, and their intent to establish the RMB as a regional reserve currency? There is no credible scenario.

2. China’s net international investment position is improving.

The amount of China’s FOREX reserves (in billions), along with the monthly change, is indicated below.

China’s FOREX Reserves (in US Billions)


The PBOC’s FOREX reserves peaked at US $4 trillion in June 2014. Soon after, the decline in China’s FOREX reserves accelerated as the RMB carry trade began to unwind.

China’s policy makers made it clear to both speculators and Chinese corporations that the post-July 2010 appreciation in the RMB was not a one-way street.

China’s capital outflows accelerated, driven by a record high in outbound merger and acquisition deals in 2016. Since the $3 trillion trough in January 2017, however, China’s FOREX reserves have steadied, and sit at $3.1 trillion as of the end of May 2017. This has been supported by the country’s massive $170 billion current account surplus, for the 12 months ending 31 March 2017, along with stringent capital controls.

But stabilization of China’s FOREX reserves is only part of the story. China is the third-largest creditor nation, with a net international investment position (NIIP) of about $1.6 trillion, behind that of Germany ($1.62 trillion) and Japan ($2.81 trillion).

If you include Hong Kong, China’s NIIP of $2.58 trillion comes in second. As Japan’s experience over the last 25 years demonstrates, large declines in the currency of a major net creditor nation tend to be self-correcting. For a large net debtor nation, on the other hand, they tend to be self-reinforcing.

Since Japan’s real estate and stock market bubble burst in 1990, Japan’s policy makers and macro traders have sought to benefit by devaluing the yen or, in the latter case, short selling both the yen and Japanese government bonds. Macro traders justified this short position by citing Japan’s record high debt-to-GDP ratio, and low potential growth, among other factors. From the mid- to late-1990s and from mid-2012 to mid-2015, the yen did experience two significant devaluations against the US dollar, but in general, this strategy has not worked over the past 25 years.

In fact, the yen is currently trading at just above its post-bubble average. The reason for this benign scenario is simple: As their domestic currency declines, citizens of the net creditor nation grow wealthier as their foreign assets appreciate, thus reinforcing the country’s balance sheet and the value of its currency.

3. China’s policy makers want to make the RMB a regional reserve currency.

The goal seems to be to make the RMB a regional reserve currency. This may explain why the PBOC did not engage in devaluations with the country’s export competitors when it mattered most.

From 2001 until the PBOC returned to a managed float in July 2010, the RMB was arguably undervalued. This helped to boost exports, but it was only a supporting factor at best, and such a policy has outlived its usefulness.

The Manufacturing Institute states that China’s global manufacturing exports — as a percentage of the world’s total — increased by 1.1% a year from 2001 to 2010, rising to 15% by the end of 2010. Despite the PBOC reverting to a managed float in July 2010, China’s share of global manufacturing exports increased by about 0.9% a year from 2010 to 2013, rising to around 18% by the end of 2013.

In effect, China does not need a cheaper RMB to compete.

A devaluation of the RMB does not serve China’s interests and runs counter to its goal of positioning the RMB as a regional reserve currency. Also, if Chinese corporations want to compete in higher-value manufacturing exports rather than low-margin goods, a lower RMB would be a substantial hindrance.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/mars58

About the Author(s)
Henry To, CFA

Henry To, CFA, is CIO of CB Capital Partners, a financial services firm with offices in the US and China. Previously, he served as the lead investment consultant for the Los Angeles office of Buck Consultants. To has also worked at Lukens Energy Group in Houston, where he performed valuations on non-traditional assets such as natural gas storage fields and weather derivative contracts. He was an Adjunct Professor at the UCLA Luskin School of Public Affairs, and holds an MBA and MPP from UCLA, along with a BA in Economics and Mathematics from Rice University.

2 thoughts on “The Renminbi: Don’t Bet on a Big Plunge”

  1. Anton Elliot says:

    A great article that proves the complexity of currency effects. Quality of the goods produced will in effect drag the value of the currency upwards against other less quality producers.

  2. Henry To says:

    Anton, thank you for the feedback. I agree – it’s about quality and innovation going forward. Devaluing the RMB is actually counterproductive, as it keeps inefficient/low-quality producers in business, while discouraging innovation. Chinese producers need some “tough love,” and keeping the RMB near its current level will help ensure that.

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