Exports were unexpectedly weak in June, prompting many to question whether GDP would meet expectations given the drag from trade. This weakness also prompts a broader question about policy and whether the gradual appreciation in RMB against the USD has been policy move that should be reversed.
The Chinese export data have been difficult to interpret of late given it appears to have been skewed by those trying to get convert into RMB by pretending to export goods to special economic zones. This practice has started to be more heavily policed by policy makers, contributing to the drop in exports in the month.
While the RMB has strengthened at a gradual, managed pace against the USD, it has been rising faster on a real effective basis, mainly thanks to more pronounced global currency weakness against the USD.
It is difficult to know how much this has contributed to export weakness. Looking at the emerging Asia block as whole, exports have been down YoY, but largely thanks to weakness in the OECD.
Leading indicators are saying is now reversing, so the Chinese external sector will probably be in a better position in 2H13 notwithstanding the stronger currency.
The challenge of managing RMB policy is not just about goods and services trade, but also about managing capital inflows. One representation of this is accumulation of foreign exchange reserves, which is function of policymakers trying to sterilise the impact of foreign money coming into China.
The pace of forex reserve accumulation in China has clearly slowed, although the fact they are still rising suggests there is still excess foreign interest in holding RMB assets for policymakers liking.
This would suggest that markets doesn't feel the RMB is too strong, although perhaps the risks have shifted. The real test of whether RMB appreciation has gone too far will be if FX reserves start to decrease.
This capital flight would be a huge change in perception on China by markets. But it shouldn't be a dynamic that is too damaging to the Chinese economy if policymakers recognise the risks, as they certainly have the firepower given FX reserves of over US$3.5 trillion.