This week the US Department of the Treasury issued a report to Congress on Foreign Exchange Policies of Major Trading Partners of the United States. Bilateral trade imbalances are a key concern for this US administration and the report monitors ‘where unfair currency practices may be emerging and encouraging policies and reforms to address large external surpluses’.
The Treasury looks at 3 criteria in compiling a ‘Monitoring List of major trading partners that merit close attention to their currency practices’: First, ‘a significant bilateral trade surplus is one that is at $20 billion’; Second, ‘a material current account surplus is one that is at least 3 percent of gross domestic product’; and third, ‘persistent, one-sided intervention occurs when net purchases of foreign currency are conducted repeatedly and total at least 2 percent of an economy’s GDP over a 12-month period’. In the latest report, the US Treasury named China, Japan, Korea, Germany and Switzerland as trading partners whose currency practices require monitoring but refrained from naming any major trading partners as currency manipulators.
Interestingly, Taiwan was removed from the monitoring list having only met one out of three criteria (a material current account surplus) in the past two reports and reflecting reduced foreign exchange intervention. But India was flagged as moving in the wrong direction having stepped up the ‘scale and persistence’ of net foreign exchange purchases to ~1.8 percent of GDP and having a significant bilateral goods and trade surplus with the US.
Despite, Donald Trump’s rhetoric the report only went as far as saying that China, with a trade surplus of USD356bn over the four quarters to June 2017, continues to be scrutinised and that the US is ‘concerned by the lack of progress made in reducing the bilateral trade surplus’. It even acknowledged that in spite of ‘the extremely large and persistent bilateral trade imbalance, China’s multilateral external position has undergone greater adjustment in recent years, with its current account surplus falling to 1.4 percent of GDP in the first half of 2017 from 1.8 percent of GDP in 2016, and down from 10 percent of GDP in 2007. Further, after engaging in one-way, large-scale intervention to resist appreciation of the renminbi (RMB) for a decade, China’s recent intervention in foreign exchange markets, tightened capital controls, and increased discretion over setting the daily fixing rate of the RMB have likely prevented a disorderly currency depreciation that would have had negative consequences for the United States, China, and the global economy.’
In fact, this year the renminbi has appreciated 4.4 percent (to the end of September) versus the US dollar although weakened 0.5 percent against China’s Foreign Exchange Trade System (CEFTS) nominal basket, a trade-weighted basket of 24 currencies published by the PBOC, countering any suggestion of ‘unfair currency practices’.
While it is true the renminbi has done well year-to-date, we still see scope for it to appreciate helped by China’s positive NFA position and a persistent, albeit smaller, current account surplus. Moreover, the renminbi remains undervalued on an income adjusted purchasing power parity basis (Big Mac data) and the US dollar should peak as the Fed tightening cycle runs its course. When the positive carry is factored in (Chinese rates are higher than US rates) the return from holding renminbi is further enhanced: YTD the renminbi (CNH) total return is 9.09 percent compared to 5.35 percent on a spot basis.