What's new: The renminbi exchange rate has entered a
de facto new regime – featuring a quasi-hard-peg to the
US dollar – since July 2008. With the global economic
recovery under way and the US dollar under renewed
downward pressures, market observers have started to
cast doubt over the sustainability of the new regime and
wonder what exit strategies exist for the renminbi.
Conclusion: We believe the current renminbi exchange
rate arrangement will remain unchanged through 2009
and most probably through the next 12 months. There
are two likely exit strategies: 1) resumption of gradual
appreciation against USD under a de facto crawling peg
regime, and 2) a genuine and transparent peg to a
currency basket. The latter is more likely to be adopted
than the former, in our view. However, there are several
strong arguments for maintaining the status quo.
Between exiting the current regime and maintaining the
status quo, we assign a higher subjective probability (i.e.,
65% vs. 35%) to the former. However, the longer the
status quo is maintained, the more likely a de facto G2
(i.e., US and China) common currency arrangement
could further shape up in the next 3-5 years, in our view.
Implications: The relevant debate at the policymaking
level, and speculation among market participants, as to
what would be an exit strategy for the renminbi is likely
to emerge sooner rather than later, in our view.
However, an actual decision – be it an exit strategy or
maintaining the status quo – is unlikely to be made and
implemented until after the middle of next year, in our
view. Strong pressures on, and market expectations for,
the renminbi to appreciate will likely re-emerge as early
as the end of this year. By then, China will likely repeat a
very similar situation to that during 2005-2008, featuring
strong expectations of renminbi appreciation, hot money
inflows, abundant external-surplus-driven liquidity (as
opposed to the current abundant liquidity due to loose
monetary policy), and the attendant upward pressures
on asset prices.