The renminbi exchange rate against the US dollar continues to rise, confounding many market observers who have expected it to decline once the US election and China's 18th CPC National Congress are over.

My interpretation is that while China's commercial banks had purchased large amounts of US dollars from individuals and companies, the People's Bank of China (PBOC) had, for all intents and purposes, suspended purchases of US dollars from the banks. So while the banks purchased 130 billion yuan worth of foreign currency in September, much of it US dollars, the central bank was only willing to buy 2 billion yuan worth of foreign currency from the banks. As a result, commercial banks now find themselves sitting on a large and growing pile of rapidly depreciating US dollars.

According to what we gather, this has lead to the notion in the market that the central bank is intervening less in the foreign exchange market and is comfortable allowing market forces to decide the direction of the Chinese currency even if it entails wider fluctuations.

The market also believes that the government has come to realize that renminbi appreciation will benefit the country more than hurt it as it will generate much-needed income to boost domestic consumption without significantly undercutting exports of labor-intensive products characterized by low demand elasticity.

The market, therefore, believes the Chinese currency will remain under pressure to appreciate given the country's mounting trade surplus in the fourth quarter of 2012 and for long as the PBOC is content to spend more time on the sidelines of the foreign exchange market.

In my view, the PBOC has turned to exchange rate adjustments over either reserve requirement ratio (RRR) or rate cuts as the main tool of its monetary policy. Should the trade surplus start to balloon or in the event of a surge of capital inflows, we would expect the central bank to forestall domestic inflation by permitting the yuan to appreciate.

However, the country's economic fundamentals, including moderating GDP growth and a declining trade surplus over the medium term, do not support rapid appreciation of the Chinese currency. The currency is expected to remain relatively stable at around 6.23 against the US dollar by the end of 2012, and is forecast to rise by 2-3 percent against the green back next year once China's economic recovery becomes more evident to the market.

The author is a director of CCB International Securities Research. The views expressed here are entirely her own.

(HK Edition 11/20/2012 page2)