China’s renminbi dilemma

December 21, 2016 / By

On 1 October, China’s renminbi (RMB) was officially added to the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) currency basket, which an IMF official termed a “milestone in the integration of the Chinese economy into the global financial system”.

Two months in, what initially appeared to be structural changes supporting greater international use of the RMB now seems over-ambitious, as the Chinese yuan has not achieved the anticipated results and has continued depreciating, hitting an eight-year low on November 21.

RMB depreciation dilemma

China is undergoing a difficult but necessary transition from an economy built on manufacturing and exports, to one that focuses on services, domestic demand and innovation. This shift has resulted in a slowdown in economic growth, which the Chinese authorities have responded to by lowering interest rates and encouraging banks to lend. The original plan was to have private sector investment lead the growth; however, the result was more money pouring into home purchases, pushing property prices to record-highs.

China’s lower economic growth and concerns about the stability of its financial system have led to pessimism from investors, and outbound capital flows continue to pressure down the RMB. Since late 2015, the People’s Bank of China (PBoC) has been selling its dollar-denominated securities and buying yuan. Based on the PBoC’s latest data, China’s foreign exchange reserve fell for a fifth straight month in November, dropping another US$69.06 billion to US$3.05 trillion. Over the past year, the PBoC has spent almost USD$ trillion to defend its currency, with limited ability to reverse the trend.

A quick fix to the problem would be a one-time sharp decline of the currency, but the results could be counterproductive as it would hit investor confidence hard and would be a step back from all the efforts China has made in the past to have the RMB internationalised. This is why China is now caught up in this dilemma.

US Fed rate hike: limited impact to property demand

With China’s currency predicament and the US Federal Reserve’s recent rate hike, the RMB will likely see more downward pressure in the next few months. However, the US Fed’s rate hikes should have limited impact on China’s property prices and demand. While capital outflows are expected, China’s tightening of capital controls will leave most Chinese investors limited options but to invest domestically.

Taking Q3 2016 as an example, Chinese investors accounted for 93 percent of all the transactions in China, a clear indication the market is now primarily a domestic player’s game. We continue to expect Chinese investors to be the main buyers in China’s market, and Chinese insurance companies to expand their real estate exposure in the domestic market.

With ample liquidity in China, we predict that prices will remain high, and with lots of money chasing limited supply, yield compressions will likely continue as well, especially in tier-one cities such as Shanghai, Beijing, Shenzhen and Guangzhou.


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