CFETS RMB Index likely to drop further in coming weeks to attain RMB REER stability

China’s consumer price index inflation decelerated in June to 1.9 percent from 2 percent in May, exceeding market projection of 1.8 percent. But the deadly floods across the nation is likely to accelerate food prices in the months ahead, noted Scotiabank. The CFETS (China Foreign Exchange Trading System) RMB Index is still likely to drop further in the weeks in order to attain the stability of RMB REER (Real Effective Exchange Rate), added Scotiabank.

According to CFETS’ recent statement, the domestic price level “is another influential factor for the RMB exchange rate depreciation. Current inflation of China is on a level generally higher than the US, resulting in some depreciation pressure on RMB NEER (nominal effective exchange rate) to maintain RMB REER (real effective exchange rate) relatively stable.”

Moreover, CFETS noted that the RMB exchange rate was at a high level that might not show the level of equilibrium and therefore rendered adjustments reasonable. In June 2016, China’s foreign reserves recovered to USD 3.205 trillion from May’s 3.192 trillion, surpassing consensus projections of USD 3.167 trillion. The surprising increase in China’s stock of foreign currencies is partially because of rising JPY last month, according to Scotiabank.

But the authorities are likely to tighten the current rules on crossborder flows to avert capital exodus stimulated by expectations of the yuan’s continuous depreciation. CFETS has stated that foreign banks must keep aside 20 percent reserve deposits effective from 15 August if their position of FX forward sales conducted in offshore markets is squared in offshore market. A requirement, similar to this, has been executed on China’s domestic banks since 2015. Moreover, the rate of interest will be zero on the reserve deposits.