Yuan will crimp commodity demand

[miningmx.com] — CHINA’S move to revalue the yuan (CY) and to replace its fixed exchange rate regime with a managed float is widely viewed as favouring a stronger rand/US dollar exchange rate – or at least restraining any future rand weakness. But there are dissenting views, with some saying that the move could fuel rand weakness. It’s all as clear as mud.

The Chinese announced on 21 July that the eight-year long peg of US$1/CY8,28 would be adjusted to US$1/CY8,11 and would be allowed to fluctuate in a 0,3% band around that level. It seems that the centre of the band can move to the level prevailing at the end of a day’s trade on the next day, which leaves further room for gradual yuan appreciation.

The Chinese central bank also has discretion to reset the value. The exchange rate is set with reference to a basket of currencies and not just the US dollar. However, the Chinese haven’t disclosed the composition of the basket.

The move generated much excitement, as it was seen as the first in a series of steps to revalue the hugely undervalued Chinese currency. Soon after the move, the head of China’s central bank appeared to confirm that view when he said the revaluation of the yuan was only an “initial’ step. People’s Bank of China governor Zhou Xiaochuan, in his first public comments since the move was announced, said: “We have made an initial adjustment of 2%.’

Chinese want to cool down the export side of economy

The first reaction on global markets was for the US dollar to weaken, which in turn led to rand strength. One of the reasons why the dollar weakened was the perception that the Chinese would no longer be massive buyers of US Treasury bills. The Chinese had bought bills on a huge scale to maintain the yuan’s peg against the dollar, accumulating a $700bn stash of foreign exchange reserves in the process.

Another reason cited for rand strength is the fact that a stronger yuan makes dollar-priced commodities cheaper for the Chinese, which will encourage imports of commodities. As the rand is a commodities-based currency that could be supportive for the rand.

Brait economist Colen Garrow says that the Japanese yen, the Singapore dollar and the Malaysian ringgit may strengthen as Chinese demand for goods and services in those countries is encouraged by a stronger yuan. “Stronger Asian currencies suggest stronger demand for gold, and possibly increased demand for commodity-linked currencies – such as the rand.’

But Investec Asset Management strategist John Clemmow disagrees. He says that the key to China’s action lies in the release of its gross domestic product numbers two days before the yuan revaluation, which showed that the Chinese economy remains in danger of overheating.

Says Clemmow: “The Chinese want to cool down the export side of the economy by strengthening the currency. The planned slowdown will curb demand for commodities, which should have a negative impact on commodities-based currencies such as the rand.’

He says the Chinese government is concerned about the strength of its domestic economy and the misallocation of capital. One sector where over-investment in capital has taken place is steel, where there’s much surplus capacity, leading to the dumping of output on global markets. That’s already resulted in a plunge in global steel prices, which could have knock-on effects on the fragile Chinese banking system.

China’s first-half GDP grew 9,5%, maintaining the pace set in the fourth quarter of last year. Clemmow says that the growth was much stronger than the market had expected. The data pointed to a robust economy, supported by an export boom that’s fuelling US protectionist sentiment. The trade gap between the US and China was $72,5bn in the first five months of this year, by far the largest trading gap with any country.

The answer as to the effects of the Chinese move on the rand depends, of course, on the extent of further revaluation of the yuan. Yu Yongding, a member of the central bank’s monetary policy committee, said there would be pressure in the short term for further yuan appreciation. However, the People’s Bank of China at end-July issued a statement contradicting the view that further steps are imminent. “The 2,1% adjustment doesn’t mean that the yuan exchange rate has been appreciated as a first step and that there will be further adjustments,’ the bank said.

JP Morgan emerging market currencies strategist Graham Stock says that the new policy should be bullish for the rand. But the central bank’s most recent statement suggested there would be little change in the yuan until year-end – hence the effects on the rand will be modest.