In July 2005, the Chinese authorities announced a one-step revaluation of the USD/RMB exchange rate of 2%. Since that time, the RMB has appreciated 24% (~4% per annum). The currency has also exhibited very low volatility during periods of financial market stress. After a period of strong currency appreciation against the US dollar following the July 2005 currency reform, the market’s near-term expectation for RMB appreciation has somewhat reduced in recent months.
From a policy development perspective, a gradual capital account liberalisation suggests that policy makers in China are now more confident to introduce more two-way fluctuations in the RMB, which is a key milestone for RMB internationalisation. In the medium-to-longer term standpoints, one of the ultimate objectives of RMB internationalisation is to have a free floating currency. However, this does not mean the RMB will no longer appreciate from the current level.
From a cyclical standpoint, the slowdown of Chinese economies and lower inflation expectations suggests that the pace of RMB appreciation against the US dollar should slow down. Having said that, a persistent depreciation is unlikely in our view as this undermines efforts to internationalise the currency. While we do not think that adjustments of RMB exchange rates could help in addressing the US-China trade imbalance, political pressure from the US is still an important consideration, especially during an election year, so it is still unrealistic to expect significant depreciation of the currency. This makes the RMB currency an interesting proposition for international investors.