RMB Exchange Rate Breaking Seven Should Pay More Attention To Reversal Risk

The central parity of the RMB against the US dollar broke seven, which has become a reality in April 10th. The exchange rate of 6.992 yuan to 1 US dollars has created a new record of RMB exchange rate since 2005. At this point, according to the 8.2765:1 ratio of RMB to us dollar before the reform, the current appreciation rate of RMB against the US dollar has exceeded 18%.

However, the exchange rate adjustment of a post industrial economy can hardly be a one-way appreciation. Although the renminbi will undoubtedly appreciate further against the US dollar in the long run, we must not ignore the risk of the reversal of the RMB exchange rate in the medium term, and this risk is accelerating.

Despite the slowdown in export growth, the surplus pattern of China's trade balance is still difficult to change in the foreseeable future. In China with double surplus in current account and capital account, the risk of the reversal of the RMB exchange rate trend comes mainly from the reversal of capital flow direction. The potential risk of the reversal of capital flow direction comes from the following two basic mechanisms: the contagion of the subprime mortgage crisis in the US, and the fact that the international floating capital believes that the mainland's exchange rate and asset market returns to the top and cash in, the accumulation of huge retained earnings in China's foreign-funded enterprises, and the lending of overseas venture capital to China market and other factors will strengthen the impact of the two basic mechanisms.

The most dangerous way for us subprime mortgage crisis to hit China is not through trade links, but through the contagion of financial markets.

Any investor has a "local preference". Western investors usually regard emerging market investment as marginal investment, whose main effect is only to supplement the low yield of mainstream investment (mainstream investment).

Once major changes in the macroeconomic environment of the western countries (such as raising interest rates, thereby reducing the advantages of investment gains in emerging markets) or reconfiguring assets in the face of heavy losses, Western investors may be able to withdraw large amounts of investment in emerging markets. This is one of the important mechanisms of the international financial / monetary crisis. Even the United States, the only "central" country, may have similar effects on the "marginal" countries such as Europe and Japan.

Since the rise of RMB appreciation expectations in the second half of 2002, the international hot money (its main body may also be a large number of Chinese residents and enterprises) flows into mainland China, and the hot market of property market and stock market in mainland China has further stimulated their inflow.

However, to date, China's property market has been on the sidelines, and the stock market is even more sluggish. The continued appreciation of the RMB exchange rate has also been approaching the peak of this appreciation cycle. If the international hot money judges the gains from the mainland's exchange rate and asset market, their cash flow reversion operation will hit the RMB exchange rate badly.

Moreover, the appreciation of the RMB exchange rate against the US dollar in exchange rate reform is essentially a manifestation of the depreciation of the US dollar, but the US dollar exchange rate which is depreciating for a long time is accumulating momentum of rebound. Many international financial markets generally expect that the US dollar will rebound in the second half of the year, and the rebound of the US dollar will crush the moisture in the appreciation of the RMB against the US dollar, thus increasing the pressure on the exchange rate of the RMB against the US dollar.

Because the Central Bank of the United States and Europe has eased the money to save the crisis, the people's Bank of China has maintained a tight monetary policy in order to resist inflation. The trend of domestic and foreign interest rates is opposite. Many overseas investors are actually lending to the Chinese market. If the crisis deepens, their solvency will be weakened, they will probably have to accelerate the dumping of Chinese assets.

The huge retained earnings of foreign-funded enterprises in China will magnify the impact of these mechanisms.

Although China's economy is under tremendous pressure of adjustment due to the appreciation of the renminbi, once the RMB exchange rate has depreciated sharply, we will also face a serious impact. In particular, enterprises that borrow large amounts of foreign currency debt in order to reduce interest expense and earn additional exchange proceeds will fall into the position of the Korean consortium after the 1997 financial crisis. We must pay enough attention to these risks.