Profile of China’s Yuan – Characteristics and Economic Indicators

The renminbi is the official currency of the People’s Republic of China and it translates as “people’s currency”. The yuan is the basic unit of the renminbi, but it is also used to refer to China’s currency in general on an international level. The renminbi’s ISO code is CNY (abbreviation for Chinese yuan), but CNH is used when it is traded in Hong Kong. The abbreviation RMB is also often used. It is the official currency in mainland China, but not in Hong Kong, Macau or Taiwan and is issued by the China’s central bank – the People’s Bank of China. There are several important characteristics of the renminbi we are about to discuss, that play a major role for the increasing demand for the renminbi, as well as its alleged future of reserve currency.

As China’s economy continues to expand, albeit at single-digit rates, it has already become the world’s second biggest economic power (third if you count the European Union’s output). This implies that demand for the renminbi will continue to rise alongside the jump in trade volumes. Moreover, the ongoing currency restrictions liberalization will play a major role in the growing interest towards the yuan.

Until less than a decade, the yuan was pegged to the US dollar at 2.46 yuan per USD. However, as China sought to switch to a market economy and gradually opened in the 1980s, the yuan was depreciated in order to give China a competitive edge on the international trade scene and boost exports. The renminbi’s value swung from 1.50 yuan per dollar in 1980 to 8.62 yuan in 1994, fueling a currency war between the two countries.

The peg was removed on July 21st 2005 and revalued the USD/CNY cross at 8.11. The yuan saw a gradual appreciation during the next three years before it was re-pegged to the US dollar in the dawn of the 2008 financial crisis. On June 19th 2010, the People’s Bank of China announced it will undergo reforms of the renminbi’s exchange rate regime and increase its flexibility. Ever since the yuan has been steadily increasing in value against the US dollar, as the Chinese government seeks to rein in inflation, hitting a record high of 6.0395 yuan per U.S. dollar on January 14th 2014.

Next global reserve currency

Chinese leaders’ determination to put the country on a new course and achieve renminbi internationalization and status of reserve currency faces three goals: to encourage its use in cross-border investment; to develop offshore renminbi centres; and to expand its role in foreign trade settlement (it has already overtaken the euro to trail only to the US dollar). The reforms finalized at China’s Third Plenum in November 2013, which were seen as the boldest in decades, maintained that direction and, as a result, several foreign central banks now hold yuan reserves, indicating improving confidence in the yuan as a reserve currency.

Although it is not crucial, the size of an economy and its trade volumes play a major role in its currency gaining a reserve status. Another requirement is an open capital account, on which China learned from others’ mistakes. It opened its current account before its capital account, but kept some “soft” controls, allowing the currency to play an increasingly important role in global trade and finance, while maintaining some control over capital flows.

Other requirements are a flexible exchange rate, supporting macroeconomic policies and deep, broad and liquid financial markets ensuring a wide range of financial assets at the disposal of investors. China has already doubled the daily trading band for the USD/CNY pair to +-2%, eased interest rates on foreign-currency deposits and allowed foreign investors an easier access to Chinese markets. The band was initially 0.3% around the PBOC’s central parity. It was raised to 0.5% in 2007, then upped to 1.0% on April 14th 2012, followed by an extension to 2.0% on March 17th 2014.

Upcoming reforms in that matter will be tested in the Shanghai free-trade zone before being implemented nationwide. They include allowing foreign companies to issue yuan bonds and access the domestic equity market, deregulation of services sector, simplifying customs clearance and interest rate liberalization, cross-border trade settlement and others.

As a result of the quickly accelerating financial reforms and rising international popularity, the renminbi is expected to become fully convertible earlier than until recently expected – most likely within the next three years. This would lift the limit on individual currency purchases, give bigger quotas for foreign investors and liberate foreign direct investment.

Major economic indicators

– Gross Domestic Product – Released by the Chinese National Bureau of Statistics, the GDP growth rate is among the most important economic indicators due to its direct link to monetary and fiscal policy. Slowing rate of expansion has prompted Beijing to safeguard a targeted 7.5% annual growth by adopting different measures. Thus, as a gauge of overall economic activity, the GDP is widely tracked and provides indication of future shifts in policy. The readings are usually released around 45-50 days after the reference period, e.g. data regarding the first quarter are released around April 15th-20th. The report presents both quarter-on-quarter and year-on-year figures.

– Trade balance – As one of the world’s biggest importers of commodities across the board, while in the same time the top exporter of manufactured goods such as Computers, Broadcasting Equipment, Telephones, Semiconductor devices and many more, Chinese trade balance data are also indicative of economic activity and short-term tendencies. Apart from gauging demand for the renminbi to conduct trade with foreign companies, this indicator’s sub-components – imports and exports, show which segments of China’s vast industrial sector are picking up the pace and vice versa. They provide insight regarding short-term economic developments. The figures are released by the General Administration of Customs of the People’s Republic of China during the second week of the month after the reference month, e.g. January’s trade data are published around February 10th.

Industrial production – Released by China’s National Bureau of Statistics, industrial output measures the change in total inflation-adjusted production at manufacturers, mines and utilities. With China’s industrial sector accounting for 43.9% of the GDP in 2013, as opposed to 46.1% by services and 10% by agriculture, this indicator gives a greater insight regarding China’s current economic conditions and activity. Thus, it tends to cause a strong impact on the yuan’s market movements. Figures are released between two and three weeks after the reference month, e.g. January data are published between February 10th and 20th.

– Purchasing Managers Indexes – There are two sources of data – government statistics released by the National Bureau of Statistics, and private figures published by HSBC and Markit Economics.

China’s Manufacturing PMI, released by the statistics agency, is available on the first day after the reference month, e.g. Januarys data are released on February 1st. As with other PMI readings, it measures the business conditions in China’s manufacturing sector based on survey responses of over 700 manufacturing companies. The level of 50 is a threshold between expansion and contraction in activity in the respective sector. The government report uses a larger sample size compared to HSBC’s survey, and focuses mostly on larger enterprises, including those partially owned by the state.

China’s Non-manufacturing PMI, released by the National Bureau of Statistics, comes out two days after the manufacturing index. It measures the business conditions in the Chinese services sector and is based on a survey of over 700 companies covering more than 25 industries. Again, the level of 50 distinguishes expansion from contraction in the respective sector’s activity.

The HSBC China Manufacturing and Services PMI are published by HSBC and Markit Economics. These private surveys are almost always released within the first week after the reference month. They follow the same principle of interpretation as the government surveys, but use a different sample size and have a slightly different focus. HSBC releases a preliminary value of its manufacturing PMI usually between the 20th and 25th day of the reference month, which gives insight in regard to the monthly performance of the sector ahead of the government data.

Apart from the major indicators discussed above, other important economic data with significant influence on the yuan are consumer and producer inflation, retail sales, fixed asset investment, as well as new loans, M2 money supply etc.