Renminbi Volatility Will Increase

Some background: Upcoming reform to bring more capital to China: economist
Major reforms toward the Chinese currency's full convertibility expected in the next five months will encourage more capital inflow into China this year, Deutsche Bank said in a report on Wednesday.

The resulting capital inflow will add to the yuan's strength against other currencies and lead to more liquidity to support growth for the world's second largest economy, said the bank's chief China economist Zhang Zhiwei, though he did not specify what measures will come along.

Overseas investors still face hurdles to expand exposure to China's capital market, though the country has taken measured steps in recent years to loosen grips over its capital account.

China has pledged to make the yuan convertible under the capital account this year during the country's annual parliamentary session in March.

While China is on its way to undoing more restrictions over capital flowing through its borders, Zhang said regulators will still maintain necessary controls to keep financial risks at bay.

From 21st CBH: 人民币汇率波幅或扩大 第二强货币的上下限在哪?
According to the State Administration of Foreign Exchange announced the "2014 China international payments report," 2014 China's international balance of payments surplus of $ 257.9 billion total, down 48% compared with 2013. Among them, the current account surplus of $ 219.7 billion, up 48%; the capital and financial account surplus of $ 38.2 billion, down 89%. Although the overall balance of payments surplus presents, but more substantial decline in surplus in 2013 emerged, showing face some downward pressure on the yuan.

Experts said, looking ahead, the yuan has now vulnerable. RMB appreciation cycle lasts 20 years or over, two-way volatility will increase, there may even be a mild case of devaluation, but a large devaluation appears less likely.
Whatever your forecast for the Chinese currency is, opening the capital account widens the potential trading range for the currency and increases the odds of a large devaluation.
Hang Seng China retail banking and wealth management business executives Houxue Ming believes that "the future of the RMB exchange rate changes will have a significant period of time span, for two reasons: First, the dollar will be a long bull market; the second is China's economic slowdown, interest rates drop quasi may become the norm. "
A formula for a potentially large devaluation.
Greenwoods Asset Partners, a Hong Kong company executives had Xiaosong reply reporter said in an interview, "the RMB against the US dollar exchange rate fluctuations depends on the Sino-US trade surplus, China's monetary policy and capital account liberalization process, surrounding the national currency depreciation, as well as IMF October this year to assess whether inclusion of the RMB cross a variety of factors, such as SDR currency basket, expected future volatility of the RMB exchange rate will increase, down 2% on the benchmark exchange rate fluctuations restrictions are likely to widen."
If China fully opens the capital account this year and allows cross border flows, there is a significant risk of a major devaluation. I would say extremely high, if only because I get the sense that "the market" doesn't fully appreciate how this will change perceptions, let alone reality. The way the renminbi has behaved to date is that it falls nearly every time the reserves either stay flat or slightly decline. China's reserves are protected by the closed capital account, but once it is open, the changes in the reserves will become more volatile.

The Market is Simply NOT Expecting This to Happen
When you have been involved in the markets for many years you will probably come to realize a pattern in market behaviour. Periods of low volatility are followed by periods of high volatility. This observations tie in nicely with Nassim Taleb’s concept of fragility and anti-fragility: systems that appear stable and have not been subject to stress are inherently fragile. The more stress a system has been subject to the more anti-fragile it becomes.
A key factor is the U.S. dollar. The U.S. dollar weakened as China purchased large amounts of U.S. treasury bonds. I sense the general opinion of the opening of China's capital account is that since this is long-term bullish for China, the renminbi will appreciate. In the short-term, however, a rising yuan, caused by a rising U.S. dollar, is bad news for China. Anything is possible, but I don't see a rising yuan on top of a rising dollar as a likely outcome. More likely is China sees capital outflows, which leads to the selling of U.S. treasuries and the depreciation of the yuan versus the dollar as those treasuries are sold. The "China sells treasuries, U.S. dollar tumbles" thesis only works if China's reserves are growing or stable. If China's reserves are falling, the amount of assets backing the yuan is falling.

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