Each country also uses silver in various manufacturing processes that result in products intended for export to more developed countries. An especially notable growth of silver use has occurred in China lately as Chinese solar cell manufacturing has expanded tremendously in recent years. This and other factors have resulted in China shifting from being a major exporter of silver to being a net importer of the precious metal instead.
Furthermore, the currencies of both of these huge countries have foreign exchange rates that are managed quite actively by their respective central banks. If these exchange rates were allowed to float more freely against the U.S. Dollar, what effect would such a policy shift have on the demand for physical silver in those countries?
The Chinese Yuan
The Chinese Yuan is the official unit of account of the Renminbi, the official legal tender in the People’s Republic of China. The Yuan’s value relative to the U.S. Dollar has been actively managed on the foreign exchange market by the People’s Bank of China for many years.
The PBOC’s currency management policy has typically taken the form of an outright peg, such as during the ten year period from 1995 to 2005 when the Renminbi traded in a tight 8.44 to 8.07 range versus the U.S. Dollar. This high exchange rate was thought to be beneficial for developing China’s manufacturing export businesses.
Nevertheless, the Renminbi has been allowed to float more freely since then, with its value strengthening to its current level of 6.3235. The managed float partly came about due to criticism and growing pressure from U.S. officials about the persistent undervaluation of the Chinese currency contributing to a large trade deficit between the United States and China.
Most analysts would agree that even this lower exchange rate considerably undervalues the Renminbi on a Purchasing Power Parity (PPP) basis, making goods substantially cheaper to purchase in China than in the United States. For example, the International Comparison Program estimates that the USD/CNY exchange rate on a PPP basis is only 3.45 Yuan per U.S. Dollar.
If the Renminbi were permitted by the PBOC to appreciate to achieve its PPP value, then silver would very likely be even cheaper in Chinese currency terms than it is now, thereby prompting even greater demand for the precious metal among the massive Chinese population.
The Indian Rupee
The Rupee is India’s official currency, and it has a market determined exchange rate versus the U.S. Dollar. Nevertheless, its value is actively managed by the Reserve Bank of India to prevent excessive exchange rate volatility.
The Rupee has been trending lower since forming a base at 7.72 in the early 1980’s, which has been a key factor behind persistent physical silver purchases by individuals based in India.
Another contributing factor is the consistently high inflation rate in India, which is running at almost 7 percent per year by recent estimates. The RBI also cut its benchmark interest rates by a greater than expected 0.5 percent in April, further undermining investor interest in Rupee denominated assets.
The Indian currency also just hit an all-time low versus the U.S. Dollar of 53.83 on May 9th before the RBI stepped in to prohibit those exporting goods out of India from retaining 50 percent of their foreign exchange earnings. The Rupee recovered substantially on that news, which was expected to result in an extra supply of $3 billion that would need to be sold for Rupees.
Nevertheless, the International Comparison Program estimates that the USD/INR exchange rate on a Purchasing Power Parity (PPP) basis is only 14.67 Rupees per U.S. Dollar. If India allowed the Rupee to appreciate substantially toward its PPP value, the price of physical silver would become much cheaper in local terms, also spurring already buoyant local demand for the hard currency.
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