Is China going all-in with $3 trillion?

The price of the renminbi has been rising sharply lately. Will China finally let the currency mature, will it use its huge foreign exchange reserves to slow down the rally, or is there more to it?

The news that China's foreign exchange reserves rose slightly in October, to over $3,2 trillion, received a lot of attention in the financial media. It is not necessarily surprising that the stock of dollars, euros and other currencies of the largest export economy in the world continues to grow. After all, that export engine is running at full speed again. In October, the export value of goods and services increased by 27% to $300 billion from a year earlier. This means that the Chinese export value is already higher after ten months than in the whole of 2020.

On the other hand, imports are also increasing rapidly. The Chinese industry has an enormous need for raw materials. Moreover, energy demand rose sharply in October due to a cold wave. Coal imports in that month were almost twice as high as a year earlier and the total import value rose by 20%.

Tailwind for the Renminbi
The strong export growth (besides the size of the foreign exchange reserves) is also a tailwind for the renminbi. However, the strength of the currency this year is mainly the result of the policy of the Chinese central bank. In many western countries and in Japan, interest rates have been cut to near or even below zero (in view of the pandemic). That rate has been almost 0% in China for more than a year.

The central bank has also tightened the handbrake somewhat on credit growth by raising the capital requirements for banks. As a result, these parties have less money left to lend to consumers and companies. With these measures, the policymakers want to prevent the bubble in the real estate market from being inflated too much. The impending bankruptcy of real estate giant Evergrande underlines the danger of too rapid credit growth.

Tourist stop
In addition to large, growing exports and an attractive interest rate, corona measures are also giving the renminbi a boost. Foreign tourism has declined enormously and there are far fewer Chinese who exchange their own currency for dollars or euros. As a result of all these developments, the renminbi has risen by 3,5% against the dollar and 6,5% against the euro over the past twelve months.

In the past, that would prompt Chinese authorities to help the export sector by pulling the renminbi down slightly. So far, however, no response has been received. Will China finally dare to let go of the link with the dollar a little more so that the renminbi can finally play an important role in the currency world on its own?

The advantage of an expensive renminbi
As is so often the case, the choice of Chinese policymakers seems to have been motivated mainly by economic pragmatism. Due to rising inflation, it is only a matter of time before interest rates in the United States and later Europe are raised. The renminbi then loses some of its shine through a shrinking interest rate advantage. In addition, an expensive currency is quite handy if you have to buy a large part of your (energy) raw materials abroad. For the time being, it seems that China would rather wait until the advance of the renminbi is slowed down by market forces than use its enormous currency reserves to pull its own currency down a bit.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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