China: Why the RMB must soften

Sunday, June 21, 2015 // Written by Enzio von Pfeil

We remain  fundamental China optimists. However, with the introduction of QDII2 this year, expect the RMB to soften: good news for exporters.

  1. SDR inclusion this month?  We were wrong about China's A-shares being included in the MSCI. " not yet" was the recent verdict. But  we'll doggedly hope that "at least" the IMF sees fit to include the RMB in its  basket of Special Drawing Rights (SDRs) by way of a soft announcement this month and a formal one in October. Yesterday's announcement (see next) no doubt was designed to further animate the IMF to such a positive, soft announcement within the next two weeks.
  2. Capital gets  to flow freely abroad.  At a wealth forum hosted yesterday in Qingdao, the Vice Governor of the Peoples' Bank of China (PBoC), Pan Gonsheng, made a momentous announcement: China "soon" will allow individuals to convert unlimited amounts of RMB into foreign currencies. Here is  this initiative's mushy mouthful: "New Qualified Domestic Institutional Investor Programme", or QDII2. The original QDII allowed only financial institutions to convert RMB based on a quota system. Now, individuals get to convert unlimited (i.e. quota-free) amounts of their RMB in order to invest abroad (QDII2).
  3. Why the RMB must soften . More Chinese mistrust their own government than foreigners trust the Chinese government. So, more domestic RMB will fly out the front door than dollars entering through the back door. All the more in that China keeps heroically clamping-down on corruption as well as making inward foreign direct investment less and less attractive to multinationals mulling their China presence. This means that the supply of RMB will exceed demand for it, aka spelling a weaker  RMB forex rate. It could fall by about five per cent against the dollar once QDII2 has been implemented fully - probably by June of next year.
  4. Monetary implications.  But with America's Congress of baboons at her currency neck, Beijing will not allow the RMB to fall too much.  Thus, she will have to  remove some of the excess RMB from the system. The PBoC will initiate this at the short end of the yield curve, as we pointed out just this Friday.
  5. Investment implications.  China's stock market will rise more than the RMB will fall over the next year. So, keep buying China on weakness: the very survival of the Communist Party depends on its keeping its constituents relatively happy, aka earning money. In the context of our Economic Clock: the excess supply of money that is created has to find a home, and the stock market is a top destination. Given the general price-sensitivity of China's exports (see my book on this subject,, buy undervalued export counters (manufacturers as well as transport-related)  before others cotton-on to this story of a softer QDII2-induced RMB. This will boost those "mirror" H-shares listed here in Hong Kong.
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