Why was the RMB Devalued? 25 FAQs on China’s Changing Currency

Why was the RMB Devalued? 25 FAQs on China’s Changing Currency
Jan 20, 2016 By eChinacities.com

The RMB has gone through three rounds of devaluation as of late November 2015. This means that Chinese goods have become cheaper on the international market. We have compiled answers to 25 questions frequently asked about the RMB’s devaluation.

1) Why was the RMB devalued?

A: The exchange rate was overvalued. In 2005, the exchange rate was at 1 US Dollar to 8.27 Yuan after a number of financial reforms. Then came a long period of appreciation for the RMB, ending at 6.1 RMB to 1 USD. This period of appreciation officially ended on August 11, 2015.

2) 10 years ago, it was estimated that the RMB would appreciate against the dollar to a 1:5 or 1:4 ration. Why was this not achieved?

A: The amount of RMB issued grew faster than China’s GDP. In the past 10 years, the amount of RMB issued in China multiplied by 3.6. This is equal to about half the nation’s GDP growth rate (after deducting price factors). This overdraft creates the potential for the RMB to appreciate in value.

3) What level will the RMB depreciate to against the dollar?

A: In the short term, the Central Bank seems to want to maintain an exchange rate at 6.6 RMB to 1 USD. It is estimated that the currency will be devalued to 7 RMB to 1 USD before its official inclusion in the IMF’s Special Drawing Right (SDR) currency basket.

4) Will the RMB to depreciate to 8 RMB to 1 USD?

A: If there are no large financial disasters (in stocks, bonds, real estate market, private lending), then it is not probable that it will happen within the year.

5) If the RMB is not devalued, what would happen?

A:  China’s capital outflow would speed up. If controls on the currency are not strengthened right away, it would be difficult to stop. China’s huge foreign exchange reserves would gradually be reduced.

6) What would happen if there was excessive deprecation of the RMB?

A: If it did not lead to a currency war, then it would lead to “hot money” (money flowing from one currency to another in the hope of quick profit). This “hot money” would flow out of China and there would be deflation. If there is a currency war, the outcome would be difficult to predict, but devaluation would be less than expected.

7)  Why can't the Central Bank devalue the RMB in one step?

A: This would lead to financial risk in the international markets. It would lead to volatility in currency and commodity markets, and would have a detrimental effect on the people.

8)  Are there several prices for the RMB exchange rate?

A: There is a small difference between the CIF (CNY) and FOB (CNH) exchange rates, which are both set by the central government. The CIF exchange rate can fluctuate ± 2% each day. The FOB exchange rate is located in in overseas marketplaces, mainly in Hong Kong.

9) Why has the difference between the CIF and FOB been so large recently?

A: Because the market expects the further depreciation of the RMB.

10)  If the two prices have long term disparities, what would be the consequences?

A: Arbitrage (the practice of taking advantage of a price difference between two or more markets). It would speed up the losses of China’s foreign exchange reserves.

11)  Besides affecting the Central Bank, what else would a long-term price disparity between the FOB and CIF mean?

A: It would affect China’s banks, which are mainly state-owned.

12)  You often hear that the RMB exchange rate rises or falls 300 basis points. What does this mean?

A: Generally, the RMB’s exchange rate against foreign currencies is announced to the 4th decimal place. For example, today’s rate against the US Dollar is 6.4936. If it rises 300 basis points, the rate will become 6.4636, and if it falls 300 basis points, it will become 6.5236.

13)  Should I change my money into US dollars?

A: If you have a practical need for it, for example, if your son or daughter is studying abroad, you should exchange money earlier rather than later. If you have a large number of assets overseas, you should also exchange currency. However, if you are just a normal person, it does not matter if you exchange your currency or not. There will be opportunities for investment in the stock market, financial products, and the real estate market which will be sufficient to counteract any losses due to devaluation. If you are lazy, or worried about risk, exchanging your currency and then investing is another option.

14) What is the impact of the depreciation of the RMB on the property market?

A: The impact is negative. However, the nation’s property market continues to be strong. The negative impact of the devaluation of the RMB has been temporarily put on hold as the government continues to strengthen controls on foreign exchange.

15)  What is the impact on the stock market?

A: The depreciation of the RMB has a positive effect on the stock market in Europe and Japan. However it will have a bearish effect on markets like Brazil. China belongs to the former group: devaluation will be good for A-shares in commodities, garments, textiles, toys, the automotive industry and others.

16) How will the devaluation of the RMB affect everyday life?

A:  Imported goods like cosmetics and cars will be more expensive. Traveling abroad, shopping abroad, and studying abroad will be more expensive as well.

17) Is the devaluation of the RMB a good thing or a bad thing?

A: It is a good thing. Having a high exchange rate is not necessarily something to be proud of, and having a low exchange rate is not something to be ashamed of. The key is to have the correct balance.

18) Who will the devaluation of the RMB help?

A: Manufacturers and wage earners.  

19) Who will it hurt?

A: Those with huge assets. Well-off families who have children studying abroad, but do not hold large amounts of foreign currency. Chinese who like to shop overseas, and middle class Chinese who want to travel abroad.

20) Will the devaluation of the RMB have any effect on the international community?

A: The devaluation of the RMB will increase the competitiveness of Chinese products, and Chinese purchasing power will be decreased. Countries that are economically dependent on Chinese purchasing power including Australia, South Korea, Chile, Japan, Peru, Brazil, Malaysia, Thailand, Vietnam and Mongolia will be greatly impacted.

21) Should I change my savings into gold?

A: Gold is a good bet, but usually only in extreme situations and economic turmoil. This is something that hardly occurs. The rate of interest on gold is relatively low.

22) How does monetary policy affect China’s exchange rates?

A:  Generally, increases interests rates and increasing the deposit-reserve ratio will increase the exchange rate. On the other time, lowing interest rates can help devalue a currency.

23)  What determines the strength of a currency?

A: The economic cycle, and whether the economy is dynamic. There is really no advance system, we can only try to protect the RMB and encourage innovation. The Central Bank does not decide the strength of the RMB—this is a common misunderstanding.

24)  Can the RMB return to a period of appreciation?

A: The key here is reform. If substantive results are achieved through reform, then China’s economic recovery will be as strong as that of the United States. In this case, the RMB could appreciate again. If reforms are not successful, the RMB is likely to continue to depreciate.

25)  How should China implement reforms?

A: The Chinese government gave this answer during the 18th Session of the Third Plenary: the key is to implement the 60 point reform plan given during the session.

Source: Wenxue City

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Keywords: frequently asked questions RMB devaluation questions

5 Comments

All comments are subject to moderation by eChinacities.com staff. Because we wish to encourage healthy and productive dialogue we ask that all comments remain polite, free of profanity or name calling, and relevant to the original post and subsequent discussion. Comments will not be deleted because of the viewpoints they express, only if the mode of expression itself is inappropriate.

golf79

+1

Jan 29, 2016 13:07 Report Abuse

VadimKonorov

I am laughing right now. I can compare...

Jan 23, 2016 10:02 Report Abuse

RandomGuy

When it comes to capital outflow, there is a safe way that they can't ever stop or restrict, virtual currencies.

Jan 20, 2016 22:46 Report Abuse

golf79

yep

Jan 20, 2016 16:32 Report Abuse

barrettchinn

Actually I thought this was quite well written and informative. It's not exactly from foreigner centered perspective (for example you can buy gold here, but try taking any significant amount of it with you and find that you'll wind up converting it back into rmb) but there is a lot of good information to glean from it. Two cheers to the author

Jan 20, 2016 09:24 Report Abuse