Alroy Commentary - The End of China’s Yuan Appreciation?
The exchange rate of Chinese Yuan was under the control of People Bank of China (PBOC) and the Yuan pegged to US Dollar at around 8.27 for a long time. Since 2005, investors liked to diversify their portfolios into Chinese Yuan after Chinese government allowed the Yuan to appreciate gradually. They deemed the Chinese Yuan as an investment tool that would appreciate against US Dollar in the future as most of the economists agreed the Yuan was undervalued against US Dollar by at least 30 percent at that time. Between 2005 and 2012, Chinese Yuan appreciated by around 32.84 percent against US Dollar.
However, investors doubt the dream of Yuan’s appreciation may over now. In year 2012, Chinese Yuan appreciated against US Dollar by 1 percent only. In July 2012, the International Monetary Fund (IMF) said the Chinese Yuan was only "moderately undervalued" against a basket of currencies in an annual assessment. It had previously called it "substantially undervalued" against the dollar - comes as the currency approaches what many regard as fair value.
Graphic 1: The Exchange Rate between Chinese Yuan and US Dollar
Despite some professionals claimed current valuation of the Yuan is closed to its fair value. However, there are still some positive catalysts of the Chinese Yuan –
As China becomes a more important trading partner with many countries and will become more important in the future, foreign governments would like to diversify their reserves from traditional asset classes such as U.S. Dollar and Euro and increase the holdings in the Yuan.
In year 2012, “hot money” out-flowed from China because investors concerned the growth prospects of China. As the economy of China bottomed-out at the end of year 2012 and global economies re-accelerated this year, “hot money” is likely to return to China and reignite the expectation of Yuan’s appreciation.
The trade balance between China and U.S. hit record high in 2011. Chinese government may allow the Yuan appreciated against US Dollar to lessen the political pressure from U.S.
Over last few years investors saw Chinese Yuan appreciated by more than 30 percent, and the deficit in current account shrank significantly from year 2007 to year 2012, Chinese Yuan may not repeat its strong rally investors saw in last few years. However, given the positive catalyst in the above paragraphs, the dream of China’s Yuan may not over yet, but only slower. Of course, investors should beware of currency fluctuation risks. And the floating band of the Yuan’s trading prices against the US dollar since the April 2012, the exchange rate of Chinese Yuan will be more volatile.
Read More: Alroy Commentary - What are the factors that move Exchange Rates?
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