China Central Bank Allows Yuan to Appreciate Short-Term
SHANGHAI, June 21 (SMM) – The People’s Bank of China, the central bank, said in a statement on Saturday, June 19 that it will proceed further with the reform of the yuan exchange rate regime to enhance the rate flexibility of yuan, also known as renminbi (RMB)". The move has been interpreted as the start of allowing the yuan to rise against the US dollar after the currency’s 23-month peg to the US dollar since the eruption of global financial crisis in 2008. The yuan met fresh pressure from the US a week before the Fourth G20 Summit on June 26-27th. Chinese officials made a clear response on a briefing meeting on June 18th that the yuan is a sovereign currency, and any decision on reforming its exchange rate mechanism should be made by the Chinese government based on actual conditions. SMM believes China’s latest move to reform the yuan exchange rate should be seen as an effort taken by Chinese government in a pragmatic and flexible manner, to break the exchange rate deadlock, and safeguard the recovery of global economy.
China to Proceed with Gradual Reform of RMB Exchange Rate
Any hints concerning the pace of the RMB appreciation after recent China's RMB pledge should be gotten from China's reform of the RMB exchange rate since 2005. China's Central Government will not make a one-off large-scale appreciation in the RMB exchange rate after the failure of Japanese exchange rate reform. In this context, China decides to proceed with the gradual reform of the RMB exchange rate. However, this move also has disadvantages based on the experiences from July 2005 to August 2008. Large amounts of overseas hot money flowed into China due to investor expectations of possible profits brought by the RMB appreciation, which in turn pushed up financial market prices and property prices, and this situation finally changed until the global financial crisis erupted. SMM believes the RMB appreciation will move into an uneven track, and SMM predicts the RMB will appreciate by approximately 8% against the US dollar by 2013 based on the pace of RMB appreciation over the past years and the results of stress test, with the gains expected to be lower than a rise of 8.27% after the exchange rate reform in 2005.
RMB Appreciation to Rein in Inflation
China's inflation emerged as China's economic climate inched up consecutively and China's economy grew rapidly driven up by China's Central Government's large-scale stimulus package in 2010. In addition, international commodities prices advanced rapidly in 2009 supported by continuous depreciation of the US dollar and surging China's demand for crude oil, iron ore, and nonferrous metals, which in turn drove up domestic commodities prices to move higher and exerted impact on end-users rapidly.
According to China's National Bureau of Statistics (NBS), China's February consumer price index (CPI) was 2.7%, higher than market expected, while China's March and 1Q CPI was 2.4% and 2.2%, respectively, generally in line with market expectations. However, China's CPI was 2.7% in April, and even reached 3.1% in May, exceeding China's target of 3% set by China's 2010 government work report, an indication of heavy pressure from inflation in China. In this context, China has to carry out tightening monetary policy in order to rein in inflation. However, after China's previous moves to issue large amounts of treasury bonds and to raise the deposit reserve requirement ratio for three times failed to curb inflation effectively, China's Government is unwilling to raise interest rates when major European countries and the US did not lift their interest rates, and since current economic recovery is not solid. SMM believes the appropriate RMB appreciation will help curb inflation to some extent through adjusting the trade balance. In general, China's central bank decides to proceed with the RMB exchange rate this time due to the external pressure and domestic structure adjustment program.
RMB Appreciation to Push up Base Metal Prices
Base metal price trend has a close correlation with RMB movement. Ever since the RMB exchange rate reform in July 2005, RMB versus the US dollar fell below significant level of 1:8 and 1:7 consecutively. From the 2H 2008 till now, RMB exchange rate had moved stably at 1:6.8. During those RMB exchange rate fluctuation periods, Base metal prices also experienced violent movements. It can be seen that Shanghai metals had gradually entered bull market since July 2005, which was mainly attributed to influx of large amount of hot money, causing ample liquid enter into equity and commodity markets and causing an enormous economic bubble in 2007 in China. In contrast, when RMB ceased to appreciate in August 2008, base market prices plummeted and didn’t bottom out until the government adopted an extremely loose monetary policy. In this context, if RMB continues to appreciate, a similar ripple effect like the case from 2005 will be triggered again, and the impact from hot money on Chinese economy will undoubtedly pass on to base metal markets.
Moreover, China’s purchasing power in the international markets will increase along with the RMB appreciation. As a country that imports a large amount of base metal metals, China’s imports of base metals will increase along with the currency appreciation, enlarging demand for international commodities and also helping push up international commodity prices. The price increase of international commodity prices will in turn push up domestic commodity prices. In this context, domestic metal prices will rise along with strong LME metal prices. It can be seen RMB appreciation will lend dual driving forces for metal markets, and these driving forces will help base metal markets experience strong performance.
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