I get paid in US dollars, but live on RMB. So as a matter of course, my morning routine includes a glance at the current exchange rate between the two currencies. That routine has been boringly predictable since China pegged the RMB at 6.83 to the dollar in July 2008.
Although the policy makers in Beijing had been allowing the RMB to slowly appreciate for several years—it was 8.15 RMB to the dollar when I moved to China in July of 2006—the peg was an obvious protectionist move to help stem the flight of foreign buyers of Chinese goods when the Western economies began to edge towards recession. And Western policy makers, who are keen to restore demand within their home markets, have been crying foul ever since.
But perhaps my mornings will once again be graced with some variety and Ben Bernanke can gripe about something else. China’s Central Bank director recently acknowledged the peg as a temporary remedy for the first time since its implementation. Those who are familiar with the subtleties of Beijing’s political signaling will recognize this as potentially preparatory for a loosening of the currency control, which would most certainly lead to the RMB’s continued rise against the dollar, and help to improve the massive trade imbalance between the US and China. Why, you ask, am I so certain that the RMB should rise, as opposed to fall?
There are many arguments, but perhaps the most concise, and certainly the drollest, is the one made by the Economist’s Big Mac Index, which asserts that were all currencies valued properly, a McDonalds Big Mac—which is taken as a homogenous commodity sold in 120 countries—would cost the same in any currency. Noting that a Big Mac sold in the US today costs $3.57, the current price of a Big Mac in China—a mere RMB 12.5 ($1.83)—points to the RMB being undervalued by nearly 50%!
So absent a matching pay raise, it looks like my Happy Meals in China are going to become more pricy. But what more profound impact will this inevitable hike in the RMB have on my life as a foreign investment professional in China? The good news is that any previous investments made by offshore funds investing dollars into Chinese companies will see a parallel rise in the value of their holdings. I.e. all things being equal, the investment will generate a return simply by selling an RMB-based asset after the RMB has appreciated.
But that may be where the good news stops. As the dollar shrinks relative to the RMB, all future investments are going to become increasingly expensive. Our investment dollars, in other words, are going to buy smaller and smaller slices once they are converted into RMB. This is strong motivation for foreign investors to explore the emerging opportunities to set up an RMB-based fund whereby not only is the process of investing in a domestic Chinese company less encumbered, but the fund is held in an appreciating currency as it is deployed.
For the same reasons, on a macro level, the RMB’s rise is likely to help boost China’s domestic PE industry, both at home and abroad. Local PE funds, whose capital originates in RMB, will gain an increasing advantage with more purchasing power when competing against foreign funds for domestic deals. This will further shift momentum towards the establishment of a domestic PE industry, which for years has been dominated by foreign players.
It may also boost the standing of Chinese investment funds—both private and government owned—abroad. For example, the impending appreciation of the RMB is pushing some of China’s largest State-Owned Enterprises (SOE) on a spending spree. With an astounding US $2.4 trillion in foreign exchange reserves, Beijing has a strong motivation to shed dollars before they depreciate without drawing too much attention to the fact. One way to do this is to sanction SOEs to invest in foreign assets, especially those that China needs most, and those which will be most likely to appreciate.
Case in point: coal. Several of China’s largest coal producers have recently been looking to purchase coal reserves abroad. These transactions will likely be financed form cash on the balance sheet of the SOE as well as from government-backed investment funds, enabling the government to spend dollars on a commodity that will almost certainly appreciate. And given that 70% of China’s electricity is generated from coal, they can be sure that it won’t go to waste.
That said, any exuberant rush to buy RMB should be tempered by the fact that even when the RMB is un-pegged, which I expect will occur sometime this year, it will not float freely. The most likely scenario is that the Chinese Central Bank will permit a resumption of a controlled, gradual appreciation by allowing the RMB to float only within a specific range over a given period of time. So I’m not expecting too much excitement in my morning routine any time soon.
Disclosure: Nothing to disclose.
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