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With the most anticipated financial market event for the past two years announced on July 21 – the Chinese government finally revamped its exchange rate regime – Standard & Poor’s Ratings Services says the initial adjustment, however, is small, and more changes are expected. In the near term, the exchange rate regime change is unlikely to have any credit impact to most entities.


China’s small step is significant and should lead to further progress in improving its monetary flexibility, and economic and financial structure. The Chinese authority revalued its currency upward 2.1% to Rmb8.11 to the US dollar and adopted a managed float to an undisclosed basket of currencies.

In addition, the renminbi will be allowed to trade within a daily band of 0.3% to the U.S. dollar around a rate set by the central bank, People’s Bank of China (

  • PBOC). These adjustments are in line with market expectation, and yet it creates significant uncertainties in the near term. The new regime leaves one guessing on further measures or changes as well as the extent that China (A-/Positive/A-1) will allow the currency to appreciate over an extended time.


    The still-weak banking system and the need for stability will compel the authorities to move cautiously in further steps, including widening the daily trading band and allowing more appreciation. The authorities are also likely to aim to preserve China’s export competitiveness. Monetary management continues to be challenging, given the political and social considerations, coupled with changing economic structure.


    However, a maturing economy and a better financial system will allow more flexibility and liberalisation in the exchange rate regime, including widening of the trading band. The change, however, works much like Chinese WTO accession – that it compels and entrenches financial restructuring and liberalisation.


    The unspecified basket of currencies provides the Chinese authorities with some flexibility to suppress large appreciation on the renminbi. In fact, all rates for all currencies and their trading bands are subject to PBOC‘s discretion, and there would be limited room for the renminbi to appreciate, somewhat alike the old regime although that was with a tighter band. However, speculative pressure could continue if the renminbi is still deemed to be undervalued.


    More speculative inflows, over and above the substantial amount (of up to US$200bn) experienced in the past two years, for further appreciation would test the monetary environment, although the authorities are still likely to be able to intervene in the market and sterilise the inflows, coupled with administrative measures to limit monetary, credit and asset price growths.

    The change so far in the new regime is unlikely to placate staunch overseas opponents, but protectionist pressure could have been diverted. Assuming the authorities are likely to adopt intervention to prevent volatility and rapid appreciation, the economic impact across the country is expected to be muted.


    Regionally, the impact on economies is also expected to be slight, and could even give a temporary boost to activities. This is based on the expectation that regional governments are likely to maintain competitiveness because exports, despite recovering domestic demand, remain the mainstay of economic growth.


    Regional currencies, are however, likely to be more volatile due to the unclear path of the renminbi, but most operating environments are attuned to market fluctuations. Appreciation pressures on currencies were already strong across Asia before the renminbi move, mainly driven by expectation of an eventual move on the currency, and this change has not dampened that belief. The saving grace for the region is that the uniform adjustments (appreciation) across all currencies will mitigate the loss of competitiveness. That leaves the Asian central bankers to continue to intervene to maintain par with each other’s currencies.


    The regional governments might even welcome a renewed douse of liquidity, and stronger currencies, in the systems to re-ignite demand, consumption, and credit growth. Monetary management would be complicated though, if the flows are sustained, and especially when asset bubbles form. Inflation fighting would also be challenging, given some central banks have already raised policy rates or tightened monetary conditions due to rising CPIs.


    The pace of interest rate increases, especially that in the US, is significant to economic fortunes. The US dollar is still likely to dominate the basket of currencies in the renminbi’s managed float, and large diversification is unlikely to take place by the Chinese and subsequently rest of Asia. The conundrum on low US long-term rates could therefore persist if Asian central bankers, including the Chinese, continue to buy US dollars and assets.


    Nevertheless, China’s exchange rate change could be the initial step of the global rebalancing process between Asian savers and central bankers, and the US spenders and treasuries/assets.