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Life under a New RMB Regime

A local CEO (chief executive officer) of an SME (small or medium enterprise) called me this week to recommend to him an accounting software package that could automatically adjust for changes in foreign currency rates. After we discussed the available options, he lamented that the easy days were over. "We never really had to worry about the [renminbi/US dollar] exchange rate," he said. "We just assumed it was a given and ran our business accordingly."

Yes, as of July 21, when Beijing re-pegged the renminbi to a currency basket instead of a direct link to the US dollar, those days really are over.

But not so fast. For SMEs whose business cycles can swing ever so swiftly between feast and famine, the change in the renminbi currency regime will probably have a smaller effect on their corporate bottom lines than any one of their latest marketing campaigns. Local CEOs do need to be wary of the change. But from the point of view of their bottom lines, the adjustments will be quite manageable.

First, note that the central bank has pegged the renminbi to a basket of trade-weighted currencies rather than a single currency (again). This means any "pent up" adjustments to the exchange rate will be reduced. Although the components of the basket and its "weights" were not publicly disclosed, the weights of the basket will likely contain a large percentage of US dollars, euros, and Japanese yen, since these are China's main trading currencies. Previously, banking authorities also said they would include the Hong Kong dollar, the British pound, the Swiss franc, the Australian dollar, and the Canadian dollar in the currency basket.

Over time, it's actually possible to replicate this basket through a series of trial and error regressions. But because the currency is pegged to a basket rather than a single currency, there is an inherent diversification benefit from the structure which will limit potential volatility in the renminbi.

Second, currently backed by over US$710 billion in foreign exchange reserves, the central bank will restrict movements to no more than 0.3 percent on either side of the mid-point each trading day. This trading band remains unchanged from the previous set up which means, based on what we have seen since the Asian Financial Crisis of 1997 and '98, the central bank has the ability to stick by this commitment, thereby limited currency volatility.

Finally, along with re-pegging to a basket of currencies, the central bank appreciated the currency against the greenback by a mere 2.1 percent to 8.11 yuan to the US dollar from 8.28 yuan to the US dollar. The message here is clearly one of stability. Indeed, the bank in the subsequent week after re-pegging, declared that nominal changes to the exchange rate will be more than the exception than the rule. In other words, I won't expect more than a 3 percent-5 percent move per year, if that much. For the SMEs whose revenue growth can double or triple in a year, such a move is not really going to make much of a difference.

Beijing's new renminbi regime is certainly an important change because it introduces another variable that can affect the bottom lines for SMEs. But this change will come slowly and over the long run. It's probably more important to worry about the effectiveness of that latest marketing campaign.  

Writing on finance and economics for the last 18 years, David Seto, CFA splits his time between Hong Kong and Beijing where he reads Chinese Classics and tries to revive his defunct band, Scarbelly. Any comments on his columns can be sent to dseto@btmbeijing.com.