China to widen RMB trading band again before end-2012

A speaker at FX Week Asia argued that further liberalisation of the RMB was on the cards in the near future

The People's Bank of China (PBOC) will further widen the USD-CNY daily trading band beyond its current 1% limit before the end of 2012, according to Chia Woon Khien, head of Asia local markets strategy at Royal Bank of Scotland.

The traded band for the China versus US dollar currency has been doubled to 1% since April 16 this year, and Chia, speaking at the FX Week Asia conference, held in Singapore last week, was bullish about a further widening being imminent.

"I've given up my bet about China cutting interest rates any further this year, but I'm sticking to the view that there will be another widening of the trading band."

On October 7, the RMB almost reached the 1% limit when it hit 6.28 to the dollar – its highest level since the Chinese authorities brought the official and market exchange rates together in 1993 – however, Chia said the pace of widening would instead be driven by China's need to liberalise its currency.

"There's a lot of imbalances in China at the moment, particularly with respect to income. This type of inequality is a function of capital misallocations and that's a result of no free market in the financial sector. Interest rates are set, the exchange rate is set – everything is prefixed by the central bank.

"To avoid this misallocation of capital, which drives the distribution of wealth, China has to move forward towards a free market. The Chinese authorities widened the intra-day trading band in April as part of this move to liberalise their economy, and they will widen it again once more before the end of the year; but that won't be the last time – the band will keep being widened it until it's free floating – this is the path to liberalisation of the RMB."

Chia was bullish over the timescale for liberalisation, and reiterated RBS's previous view that it would occur by 2015. Citing China's ambition of making Shanghai an international financial sector by 2020, she said it was crucial for the RMB to be fully convertible by 2015, when the International Monetary Fund reviews its Special Drawing Rights (SDRs) approach.

The SDRs approach represents a potential claim on the freely usable currencies of IMF members, and its value is currently comprised of euros, yen, pound sterling and US dollar. Chia said China wanted the RMB to be included in this basket.

Other panellists did not agree fully with this scenario – Philip Wee, Singapore-based senior currency economist, DBS, was optimistic that the RMB could make SDR status even without full convertibility, and was therefore unconvinced over the 2015 timeframe.

"There's a good chance the RMB will be in the SDR, but it won't need to meet full convertibility as set out by the current criteria. So I won't to commit to 2015 just yet."

Dennis Tan, senior Asian forex strategist at Deutsche Bank, was the most pessimistic over the likelihood of a 2015 goal for a free-floating currency – "three years is too short a time to reach full convertibility" – and he argued the process of liberalisation would continue at a steady pace.

"Instead, what we should expect is further examples of gradual progress, and slowly open up the exchange rate and the capital markets – giving more quota to central banks and foreign institutional investors. China has a plan – it wants to take its time with no hiccups."